1. Barkley finances only with retained earnings, and it uses the CAPM with a historical beta to determine its cost of equity. The risk-free rate is 7%, and the market risk premium is 5%. Barkley is considering a project that has a cost at t=0 of $2,000 and is expected to provide cash inflows of $1,000 per year for 3 years. What is the project’s MIRR?
The stock of Barkley Inc. and “the market” provided the following returns over the last 5 years:
Year Barkley Market
1998 -5% -3%
1999 21 10
2000 9 4
2001 23 11
2002 31 15
2. You are evaluating a project that is expected to produce cash flows of $5,000 each year for the next 10 years and $7,000 each year for the following 10 years. The IRR of this 20-year project is 12%. If the firm’s WACC is 8%, what is the project’s NPV?
3. Notice this project requires two cash outflows at Year 0 and 2, and produces positive cash inflows in the remaining periods. The project’s appropriate WACC is 10% and its modified rate of return (MIRR) is 13.50%. What is the value of the project’s cash outflow in Year 2?
A project has the following cash flows:
Year Cash Flow
0 ($250)
1 100
2 (?)
3 150
4 275
5 300
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information must complete the following tasks.
1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2. Calculate the Payback Period (P/B) and the NPV for the project.
3. Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
4. If the project required additional investment in land and building, how would this affect your decision? Explain.
Please include all references used.
1. Capital Budgeting (45 pts)
A proposal to invest in new white table wine-making equipment has been developed. The following information is now provided:
1. Equipment cost (installed) is $2 million
2. Revenues of $1M, $1.2M, 1.3 and $1.4M/yr for each of the next four years.
3. Satyr consulting generated the forecasts; their fee is $250,000
4. Operating costs are 30% of sales.
5. Net working capital is expected to be 20% of the following year’s sales (ie-NWC at t=0 is 20% of t=1 sales).
6. Assume that all new equipment will be depreciated straight line to zero over the period of t=1-4 (25% per year)
7. Introduction of the white table wine is expected to increase sales of “complementary products” such as olive oil, corkscrews, and wine glasses produced by the firm, resulting in additional pre-tax operating profits of $50,000 per year.
8. Project acceptance will require that $250,000 of debt be issued, resulting in interest payments of $20,000 per year over the life of the project
9. At project termination (t=4), all equipment will be sold for $50,000, and 75% of NWC will be recovered (the other 25% will be lost due primarily to inventory obsolescence).
10. Assume a 40% marginal tax rate and a 12% cost of capital.
a) What is the project’s NPV? Show all work. (42)
b) Assume that 12% is in fact the firm’s WACC. Do you think it was the correct rate to use for this project? Explain briefly. (3)
EXTRA CREDIT
Alternative equipment costing an additional $300,000 is available; projected operating costs and revenues are the same as the equipment described in (a) above, but this alternative equipment can easily be adapted to make rose table wine as well as white wine (the original equipment cannot be adapted to make rose). Marketing estimates indicate that the market for white table wine is superior, though, and your managers believe the additional $300K for this equipment isn’t worth it. Do you agree? Discuss. (10 pts)
2. Firm Valuation (25 pts)
XCL Corp has projected free cash flows (FCFs) of: $-2.5M, $.5M, and $1.5M at time t=1,2, and 3 respectively. They expect FCF to have a real growth rate of 2% indefinitely after t=3; in addition, inflation is expected to average 2.5% in the foreseeable future. XCL has debt of $3M, WACC of 14%, and 1M shares outstanding.
a) Estimate the price per share. (17)
b) XCL is not publicly traded; however, publicly traded firms that are similar to XCL has a P/E ratio of 15x and an V/EBIT (V=Firm Value) ratio of 5x. XCL has Net Income of $500,000 and EBIT of $2,000,000. Estimate the value of a share of XCL via:
1) the P/E multiple method (2)
2) the V/EBIT multiple method (3)
c) What are the primary limitations of using the FCF method of part (a) to value a company? Be very brief. (2)
d) What is the primary limitation of using the “multiples” method of part (b) to value a company? Be very brief. (1)
3. Cost of Capital (20 pts)
Wegs Corp has the following balance sheet (in ‘000’s):
Current Assets 60,000 A/P & Accruals 15,000
Fixed Assets 120,000 Notes Payable 25,000
L-T Debt 50,000
Common Stock 10,000
Retained Earnings 80,000
Long term debt consists of 50,000 bonds, each of which has a par value of $1,000, carries a 9% coupon rate paid semi-annually, and matures in May of 2020. The yield to maturity on this bond is currently 8%. Weg’s beta is estimated to be about 1.5, the risk free rate is 4%, and the expected market risk premium is 6%. Weg’s most recent dividend for the year was $.47, and earnings and dividends are expected to grow at a rate of 6.5% indefinitely. The common stock sells for $50/share, and has a par value of $1. The firm’s marginal tax rate is 40%. (20 pts)
a) Estimate the firm’s WACC; state clearly any relevant assumptions. (18)
b) Project Z is under consideration, and it has a rate of return 1% less than the WACC you calculated in (a). Should you accept or reject it? Explain very briefly. (2)
Ms. Sharpe, your supervisor, has asked you to analyze a capital project that the system’s staff is proposing. It is an exciting project, and given that it is your second week with the company, you want to do an excellent job, especially in presenting the results.
Based upon the information you have received from Ms. Sharpe, and based upon discussion with the IT staff, you have assembled the following information.
The computer to run the new system will cost $300,000 and is expected to have a useful life of five years. Given that there is an active “used” market for these computers the salvage value is projected to be $100,000. It will take $250,000 in programmer support to build the system and the tax manager told you that this expense would need to be capitalized (added to the cost of the computer to get it running) and depreciated along with the computer using the straight-line method. The time to build the system is projected to be twelve months.
The marketing staff is excited to have the system’s capabilities and have estimated that they could save about $95,000 per year in administrative expenses over the next five years with the system. They also suggested that sales of the product line that the system will support will increase by three percent per year over the systems life and sales are currently $4,500,000. Other marketing and advertising and expenses are not expected to changes. The product line is reasonable profitable and has a gross profit of 65%.
In your introduction to the company and the finance staff, you recall that the hurdle rate used in capital projects was 12% for projects that the company believers are routine. This project seems to qualify as “routine” based upon Ms. Sharpe’s assessment. You also recall that the company’s tax rate is 40%.
The only issue that has been raised in discussions with the marketing staff is the likelihood of the sales increases. Some members thought that three percent sales increase was too high based upon past experience. This group thought that one to two percent would be more likely.
What is your recommendation to Ms. Sharpe and why?
I get confused on what I am needing to do on problems like this.
10-12A. (Comprehensive problem) Traid Winds Corporation, a firm in the 34 percent marginal tax
bracket with a 15 percent required rate of return or cost of capital, is considering a new project.
This project involves the introduction of a new product. This project is expected to last five years
and then, because this is somewhat of a fad project, to be terminated. Given the following information,
determine the free cash flows associated with the project, the project’s net present value, the
profitability index, and the internal rate of return. Apply the appropriate decision criteria.
Cost of new plant and equipment: $14,800,000
Shipping and installation costs: $ 200,000
Unit sales: Year Units Sold
1 70,000
2 120,000
3 120,000
4 80,000
5 70,000
Sales price per unit: $300/unit in years 1-4, $250/unit in year 5
Variable cost per unit: $140/unit
Annual fixed costs: $700,000
Working-capital requirements: There will be an initial working-capital requirement of $200,000 just to get
production started. For each year, the total investment in net working capital will be equal to 10 percent of
the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1
through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project
at the end of year 5.
The depreciation method: Use the simplified straight-line method over five years. It is assumed that the
plant and equipment will have no salvage value after five years
Here is the situation. I am an account manager, I have been given an account. The account is on track to generate 1M dollars a year. I want to take 4% of the quarterly revenue and dedicate it to a marketing program that will help the account generate 1.5M at the end of the fiscal year, 1.75M at year 2 and 2M dollars at year 3. The problem is I do not know the cost, other then the 4% per quarter that I will be dedicating to marketing. In this instance can I still do a NPV analysis. The reseller (account) is selling laptops. Can I do NPV with just the cost I will be dedicating to the marketing program?
What are the three potential flaws with the regular payback method? Does the discounted payback method correct all three flaws? Explain.
Why is the NPV of a relatively long-term project (one for which a high percentage of its cash flows occurs in the distant future) more sensitive to changes in WACC than that of a short-term project?
What is a mutually exclusive project? How should managers rank mutually exclusive projects?
Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, has plans to eventually add five new chairlifts. Suppose that one lift costs $2 million, and preparing the slope and installing the lift costs another $1.3 million. The lift will allow 300 additional skiers on the slopes, but there are only 40 days a year when the extra capacity will be needed. (Assume that Deer park will sell all 300 lift tickets on those 40 days.) Running the new lift will cost $500 a day for the entire 200 days the lodge is open. Assume that the lift tickets at Deer Valley cost $55 a day. The new lift has an economic life of 20 years.
1.Assume that the before-tax required rate of return for Deer Valley is 14%. Compute the before-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
2.Assume that the after-tax required rate of return for Deer Valley is 8%, the income tax rate is 40%, and the MACRS recovery period is 10 years. Compute the after-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
3.What subjective factors would affect the investment decision?
Also please list any references.
Project S
Costs = $15,000
Cash Flow = $4500 per year for 5 years
WACC = 14%
Mutually exclusive
Project L
Costs = $37,500
Cash Flow = $11,100 per year for 5 years
WACC = 14%
Which project should be selected?
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.
1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2. Calculate the Payback Period (P/B) and the NPV for the project.
3. Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
4. If the project required additional investment in land and building, how would this affect your decision? Explain.
For more information on creating Excel Spreadsheets, please visit the Excel Lab.
To receive full credit on this assignment, please show all work, including formulae and calculations used to arrive at financial values.
Lehigh Co. established a subsidiary in Switzerland that was performing below the cash flow projections developed before the subsidiary was established. Lehigh anticipated that future cash flows would also be lower than the original cash flow projections. Consequently, Lehigh decided to inform several potential acquiring firms of its plan to sell the subsidiary. Lehigh then received a few bids. Even the highest bid was very low, but Lehigh accepted the offer. It justified its decision by stating that any existing project whose cash flows are not sufficient to recover the initial investment should be divested. Comment on this statement.
Please see attached file.
1. Fisher Electronics (FE) was considering the introduction of a new product that had 5 years of life and was expected to generate sales in Year 1 through 5 as the following:
Year 1 Year 2 Year 3 Year 4 Year 5
$10,000, 000 $13,000,000 $13,000,000 $8,667,000 $4,333,000
No material levels of revenues or expenses associated with the new product were expected after five years of sales. Based on past experience, cost of sales for the new product was expected to be 60% of total annual sales revenue during each year of its life cycle. Selling, general and administrative expenses were expected to be 23.5% of total annual sales. Taxes on profits generated by the new product would be paid at a 40% rate.
To launch the new product, FE would have to incur immediate cash outlays of two types. First, it would have to invest $500,000 in specialized new production equipment. This capital investment would be fully depreciated on a straight-line basis over the five-year anticipated life of the new product. There would be no salvage value left for the equipment at the end of its depreciable life. No further fixed capital expenditures were required after the initial purchase of equipment.
Second, additional investment in net working capital to support sales would have been made. FE generally required 27 cents of net working capital to support each dollar of sales. That is, change in net working capital in 27% of change in sales. As a practical matter, the buildup of working capital would have to be made at the beginning of the sales year in question (or, equivalently, by the end of the previous year). For example, sales in year 2 were expected to be $13,000 million, $3,000 million increase from Year 1’s sales, so a buildup of working capital of 27% of $3,000 should be made at the end of Year 1. i.e., the change in net working capital for year 1 is $3,000 million. At the end of the new product’s life cycle, all remaining net working capital would be liquidated and the cash recovered.
Finally, FE expected to incur tax-deductible introductory expenses of $200,000 in the first year of the new product’s sales. Such cost would not be recurring over the product’s life cycle. Approximately $800,000 had already been spent developing and testing marketing the new product.
Note: Except for the change in net working capital, which must be made before the start of each sales year, you should assume that all cash flows occur at the end of the year in question. To find the NPV, you need to estimate the free cash flow in each year and discount them at cost of capital of 20%.
a.) Estimate the new product’s cash flows.
b.) Assuming a 20% cost of capital, what is the product’s net present value?
c.) What is its internal rate of return?
d.) Should FE introduce the new product? Explain why?
A project has an initial cost of $65,000, expected cash flows of $14,000 per year for 9 years and a cost of capital of 11%. Answer the following:
a. What is the IRR?
b. What is the payback period?
c. What is the NPV?
Please write your answers on a WORD or PDF.
1) Tangshan Mining Company is considering investing in a new mining project. The firm’s cost of capital is 12 percent and the project is expected to have an initial after tax cost of $5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3 and ($1,300,000) in year 4? (5 points)
(a) Calculate the project’s NPV. (b) Calculate the project’s IRR.
(c) Should the firm make the investment?
2) Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after tax operating cash flows? Why or why not? (2 points)
3) Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost. (2 points)
Table 2
4) Given the information in Table 2 and 15 percent cost of capital. (3 points) (a) compute the net present value.
(b) should the project be accepted?
Table 3
Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.
The firm pays 40 percent taxes on ordinary income and capital gains.
6) Calculate the book value of the existing asset being replaced. (See Table 3) (2 points)
7) Calculate the tax effect from the sale of the existing asset. (See Table 3) (2 points)
8) Calculate the initial investment required for the new asset. (See Table 3) (2 points)
9) Calculate the earnings before depreciation and taxes. (See Table 3) (2 points)
10) Calculate the accumulated depreciation. (See Table 3) (2 points)
11) Summarize the incremental operating cash flow (relevant cash flows) for years t = 0 through t = 5. (See Table 3) (4 points)
12 ) Jake’s Sound Systems has 210,000 shares of common stock outstanding at a market price of
$36 a share. Its beta is 0.5. Market expected return is 12% and risk-free rate is 5%. Jake’s also has
6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon, pay interest annually, and mature in 5 years. The bonds are selling at $990. The company’s tax rate is
34%. What is Jake’s weighted average cost of capital? ( 3 points)
13) You are considering the following two mutually exclusive projects. (7 points)
Year Project A Project B
0 -$32,000 -$32,000
1 13,000 19,000
2 13,000 12,000
3 19,000 12,000
a) What are the NPVs for Project A and Project B given a discount rate of 14%.
A B A) 1500 2800
B) 3500 1300
C) 2231 2000
D) 2000 2231
b) What are the IRRs for Project A and Project B?
A B
A) 10.23% 12%
B) 35.40% 13%
C) 17.85% 18%
D) 25% 20%
c) What are the payback periods assuming all the cash flows come in evenly during the year
(in years)?
A B
A) 1.0 2.0
B) 3.2 1.34
C) Never payback 1.52
D) 2.3 2.08
d) Based on your analysis above, which project should be chosen and why?
See attached file.
1. The difference between the market value of an investment and its cost is the:
Net present value
Internal rate of return
Payback Period
Profitability Index
2. The process of valuing an investment by determining the net present value of its future cash flows is called (the):
Constant dividend growth model
Discount cash flow valuation
Expected earnings model
Capital Asset Pricing Model
3. The length of time required for an investment to generate cash flow sufficient to recover its initial cost it the:
Net present value
Internal rate of return
Payback period
Profitability index
4. The discount rate that makes the net present value of an investment exactly equal to zero is the:
Payback period
Internal rate of return
Average accounting return
Profitability index
5. A situation in which taking one investment prevents the taking of another is called:
Net present value profiling
Operational ambiguity
Mutually exclusive investment decisions
Issues of scale
Multiple rates of return
6. The chnages in the firms future cash flows that are a direct consequence of accepting a project are called:
Incremental cash flows
Stand-alone cash flows
Aftertax cash flows
Net present value cash flows
Erosion cash flows
7. A cost that has alread been paid, or the liability to pay has already been incurred is a(n):
Salvage value expense
Net working capital expense
Opportunity cost
Sunk cost
Erosion cost
8. The most valuable investment given up if an alternative investment is chosen is a(n):
Salvage value expense
Net working capital expense
Sunk cost
Opportunity cost
Erosion cost
9. The possibility that errors in projected cash flows can lead to incorrect NPV estimates is called:
Forecasting risk
Projection risk
Scenario risk
Monte Carlo risk
Accounting risk
10. An analysis of what happens to NPV estimates when we ask what-if questions is called:
Forecasing analysis
Scenario analysis
Sensitivity analysis
Simualtion analysis
Break-even analysis
11. An analysis of the relation between sales volume and various measures of profitability is called:
Forecasting analysis
Scenario analysis
Sensitivity analysis
Simulation analysis
Break-evem analysis
12. The return that lender require on their loaned funds to the firm is called the:
Coupon rate
Current yield
Cost of debt
Capital gains yield
Cos of capital
13. The weighted averal of the firm’s cost of equity, preferred stock, and after-tax debt is the:
Reward to risk ratio for the firm
Expected capital gains yield of the stock
Expected capital gains yield for the firm
Portfolio beta of the firm
Weighted average cost of capital (WACC)
14. The proportions of the market value of the firm’s assets financed via debt, common stock, and preferred stock are called the firms ______________.
Financing costs
portfoliio weights
Beta coefficient
Capital structure weights
Cost of capital
15. The legal document describing details of the issuing corporation and its security offering to potential investors is called the _____________.
Letter of comment
Rights offering
Offering prospectus
Regulation A statement
Tombstone advertisement
16. A public offering of securities offered for sale to the general public on a direct cash basis is called a:
Best efforts offer
Firm commitment offer
General cash offer
Rights offer
Red herring offer
17. The use of personal borrowing to change the overall amount of finanical leverage to which the individual is exposed is called:
Private debt placement
Dividend recapture
Homemade leverage
A privileged subscription offer
The weighted average cost of captial
18. The equity risk derived from the firm’s operating activities is called ________ risk.
market
systematic
extrinsic
business
financial
19. The proposition that the cost of equity is a positive linear function of capital structure is called :
The Capital Asset Pricing Model
M&M Proposition I
M&M Propostion II
The Law of One Price
The Efficient Markets Hypothesis
20. The equity risk derived form the firm’s capital structure policy is called ___________ risk.
market
systematic
extrinsic
financial
business
21. Payments made out of the firm’s earning to its owners in the form of cash or stock are called:
Dividends
Distributions
Share repurchases
Payment-in-kind
Stock splits
22. Payments made by a firm to its owners from sources other than current or accumulated earings is called:
Dividends
Distributions
Share repurchases
Payment-in-kind
Stock splits
23. A cash payment made by a firm to its owners as a result of a one-time event is called a:
Share repurchase
Liquidating dividends
Regular cash dividend
Special dividend
Extra cash dividend
24. The date by which a stockholder must be registered on the firm’s roll as having share ownership in order to receive a declared dividend is called the _________.
date of ex-rights
date of ex-dividend
date of record
date of payment
date of declaration
25. The date on which the board of directors passes a resolution authorizing payment of a dividend to the sharholders if the _________ date.
ex-rights
ex-dividend
record
payment
declaration
Please show works where applicable.
Use the table for the question(s) below.
Consider a project with the following cash flows:
Year Cash Flow
0 -10,000
1 4,000
2 4,000
3 4,000
4 4,000
1) Assume the appropriate discount rate for this project is 15%. The payback period for this project is closest to:
A) 3
B) 2.5
C) 2
D) 4
2) Assume the appropriate discount rate for this project is 15%. The IRR for this project is closest to:
A) 21%
B) 22%
C) 15%
D) 60%
Use the information for the question(s) below.
Larry the Cucumber has been offered $14 million to star in the lead role of the next three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting in other Veggie movies that would pay him $5 million at the end of each of the next three years. Assume Larry’s personal cost of capital is 10% per year.
3) The IRR for Larry’s three movie deal offer is closest to:
A) 3.5%
B) 1.6%
C) -3.5%
D) -1.6%
4) Larry should:
A) Reject the offer because the NPV < 0
B) Accept the offer even though the IRR < 10%, because the NPV > 0
C) Reject the offer because the IRR < 10%
D) Accept the offer because the IRR > 0%
5) You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is:
A) NPV
B) Profitability index
C) IRR
D) Incremental IRR
Use the table for the question(s) below.
Consider the following two projects:
Project Year 0
Cash Flow Year 1
Cash Flow Year 2
Cash Flow Year 3
Cash Flow Year 4
Cash Flow Discount Rate
A -100 40 50 60 N/A .15
B -73 30 30 30 30 .15
6) Assume that projects A and B are mutually exclusive. The correct investment decision and the best rational for that decision is to?
A) Invest in project A since NPVB < NPVA
B) Invest in project B since IRRB > IRRA
C) Invest in project B since NPVB > NPVA
D) Invest in project A since NPVA > 0
Use the table for the question(s) below.
Consider a project with the following cash flows:
Year Cash Flow
0 -10,000
1 4,000
2 4,000
3 4,000
4 4,000
7) Assume the appropriate discount rate for this project is 15%. The profitability index for this project is closest to:
A) .14
B) .22
C) .60
D) .15
8) Assuming that your capital is constrained, which investment tool should you use to determine the correct investment decisions?
A) Profitability Index
B) Incremental IRR
C) NPV
D) IRR
9)
A Small Case Study
You are the Project Manager for a team of 9 employees. Your duty is to manage the deployment of a new tool. The team is made up of:
? 4 software engineers (developers of the tool) work 40 hour weeks can put in over time:
 2 junior level (earn $50.00 an hour)
 2 senior level (earn $67.00 an hour)
? 2 trainers (train users how to use the tool), Currently training is a 6 hour course and can accommodate 20 – 25 people. Training is offered 2 or 3 times a week:
 1 full time trainer ( with 10 years of experience training and has been with the team for the past three years ( earns a salary of $100,000.00 per year)
 1 part-time trainer can train only on Mondays and Wednesdays works 8 hours on those days (has 15 years experience training earns $67.60 per hour)
? 3 help desk personnel to answers questions concerning the tool and assist users after they have completed training. Work 40 hours a week on a 9 to 5 shift
 2 full time held desk personnel both with 4 yr degrees and have minimum experience on a help desk earns $25.00 per hour
 1 full time help desk personnel with 10 years experience on a help desk no degree and earns $25.00 per hour ( has the experience to train the tool if needed)
The tool has been in existence for 3 years and has some issues. The software development team is constantly fixing the tool to keep it up and running. Currently the software engineers are in maintenance mode and that takes all of their work hours to do just that.
Your boss has announced an upgrade to the tool to be deployed in two months. It is not a complete overhaul the interface will remain the same just a couple of new buttons and functionality. With this deployment 2000 new users must be trained to use this tool within the next 18 months (this includes the two months). In addition to your budget for your current staff, your boss has given you an additional budget of $500,000 to make it happen.
A. Can you make it happen and have it look seamless to the existing users?
B. Will you need to have new training for the people that have already been trained?
C. Will you need to add any additional personnel (software engineers, trainers or help desk)? If so, how many and how many hours?
D. What do you estimate the hours for the software engineers to update the tool?
E. The part-time trainer just announced that she is leaving in two weeks, What do you do?
F. Do you have a budget to give your boss?
G. Do you have time to hire additional personnel
If you were completing a capital budgeting analysis for the firm you work for today (bank), which single financial analysis technique would you use to determine if you should spend $50,000 on a new computer server and why?I just need a paragraph. thanks
Strident Marks is considering purchasing new manufacturing equipment that costs $1,300,000 and is expected to improve cash flows by $500,000 in year 1, $350,000 in year 2, $475,000 in year 3, $450,000 in year 4, and $300,000 in year 5. Calculate key financial metrics for this capital budgeting project. A 14% rate of return and a payback period of less than five years are required for this project. These key metrics must include (1)payback period, (2) net present value, and (3) internal rate of return. (Use 6% as the weighted average cost of capital). In a memo to the CFO, discuss the metrics and make a recommendation whether to accept or reject the project. Please include spreadsheet of figures.
Questions Part I:
A:
1. Evaluate the tax shield from the interest tax deductibility
2. Evaluate the bonus from the subsidised loan granted by the European Bank for R&D
3. Calculate the Net Present Value of the project
4. Is it profitable for the FMI parent company?
–
B:
FMI thinks that, starting in year two, it will be the opportunity to export to Latin America, the 2000 Trucks which used to be exported to Romania.
What would be the impact on FMI?
C:
The leverage Ratio of RVI (Debt/ equity) is approximately 25%. Is this piece of information good news or a bad news for the profitability of the project?
Part II intro + questions
Before making the final decision, it is necessary to measure the risk, the risk premium, and the cost of capital more accurately.
This formal approach is worth doing because the EU Financial Market is transparent and financial information are reliable.
Of course, you could buy some pieces of information from financial agencies which publish financial data such as the beta, which is the key variable to measuring the risk premium.
However the access cost to such a financial data base is very expensive.
Using the same methodology as BLOOMBERG, you can evaluate your own BETA, based on the stock prices of FMI Company.
This French Company is quoted on the Paris Stock Exchange. 60 Monthly data
Stock prices of FMI, Market Index level, and 3 month Euribor, are available in the Data base: Monthly DATA
1- What is your computed BETA?
2- Given this BETA what should be the theoretical cost of capital?
3- What would your conclusions be?
Please see attached.
FM International (FMI)
Ford Motor Internation intends to build a new TRUCK assembly line in Romania. FMI Romania
Romania is a good advanced base in order to expand in the European countries, which transportation renewing needs are huge.
At this point in time, FMI, the parent company, exports 2000 vehicles each year in this eastern Zone. Its production capacity is nearly saturated, and if FMI wants to benefit from these new opening fast growing markets, investing is a necessary.
Romania has been chosen for many reasons. First many executives speak the English language; which facilitates the management; secondly, in the transition phase toward market economy, Romania is suffering from a high level of unemployment. And Romanian authorities are extremely interested in attracting such efficient companies capable of creating thousands of jobs.
The European Bank for Research and Development has agreed to 100 Million Euro 5 year loan, at 8%, redeemable in Fine; the interest being paid at the end each year.( the total amount of capital is repaid in one shot at the end of the 5th year; financial expenses are paid each year )
The total cost of the project is estimated at 500 Million Euro.
This new production line should be operational in 6 months. The skilled workers from the old “Dacia” automobile production units will be hired.
Because of the licensing contract, the Parent company will receive royalties which represent 7% of the revenue. On the top of that, FMI could also sell some spare parts with a margin of 20%.
The expected return on equity is 15% due to the risk of the project.
The Financing sources
The investment, 500 Millions Euro, will be linearly depreciated with a zero book value at the end of the 5 years.
As said, FMI benefits from a subsidised loan with a very favourable rate: 8%.
One half of the 400 Million missing will be financed with Equity and the other half with a loan of 200 Million, at 12% ( which is the market rate) redeemable within 10 years by constant annuity, with a deferred capital payment the first year; the first year only interests are paid.
Beyond the equipment in itself, we expect an increase of the Net Working Capital (Inventory + customer credit) which represents 30% of the revenue; a part of this NWC needs is financed by the supplier credit which corresponds to roughly 10% of sales.
The Romanian affiliate of the Credit Lyonnais will open a credit line of 120 Billion LEI (equivalent to 30Millions Euro) to finance the initial working capital. The change in the NWC will be self financed.
The Initial Balance sheet is as follow: (Millions euro)
ASSETS LIABILITIES
Plants & equipments 500 Equity 200
NWC 30 LT Loan from the E B R D 100
Debt from the Parent company 200
Debt Crédit lyonnais 30
TOTAL 530 TOTAL 530
Activity forecast:
The first year, the sales volume is estimated at 8000 units, with a unit price of 50 000 ?.
The sales volume should increase by 10% annually; to reach 10 648 Units five years later.
Obviously, these sales will replace the 2000 trucks which are presently exported in this east area, with a before tax margin of 25%.
Very important is the inflation rate which, on average, is 5% per month. The immediate consequence is the depreciation of the LEI.( cf the PPP theory)
In the first year, because of the 6 month operating delay, the production of the new unit will be only 4000 units. The missing 4000 units will be imported from the FMI parent company at a transfer price of 50 000?. (which means no profit for the Romanian affiliate). As said, starting from year two, the sales volume should increase by 10% annually.
Production Costs:
Production Costs will follow the inflation rate. Initially, the unit variable costs are 112 000 000 Lei (equivalent to 28000?); of which 6000? represent the price of the spare parts sold by the Parent company. This transfer price of the parts includes 25% of the Parent company overheads. In fact the variable production costs represent 75% of this transfer price.
The royalties paid to the Parent company will follow the expansion of the revenue.
The overheads of FMI Romania, for a full year, are estimated at 2.2 millions Euro; but for the first year this amount is reduced to 1 200 000 Euro.
Recall that the plants are depreciated linearly, which represents 400 Billion LEI each year
Tax system:
The Income tax rate is 45% in Romania; Any deficit can be carried forward for 5 years.
Net Working Capital needs:
The NWC needs are quite important for this type of project: The initial NWC is 30 Million ?. In average it’s equal to 20% of sales.
The Market residual Value:
The valuation of he Market residual value of a project is a “tough” issue.
In our situation the Residual Value has been estimated to 3 times the Net cash flow of the 5th year;
Dividend payment :
.
The contract says that the Romanian affiliate has to pay all the free cash flows to the Parent company, after the repayment of different loans. Remember that FMI will perceive royalties too.
A 10% withhold tax is levied by the Romanian tax authorities.
In France the Income tax on this revenue is 33%.
Questions Part I:
A:
1. Evaluate the tax shield from the interest tax deductibility
2. Evaluate the bonus from the subsidised loan granted by the European Bank for R&D
3. Calculate the Net Present Value of the project
4. Is it profitable for the FMI parent company?
–
B:
FMI thinks that, starting in year two, it will be the opportunity to export to Latin America, the 2000 Trucks which used to be exported to Romania.
What would be the impact on FMI?
C:
The leverage Ratio of RVI (Debt/ equity) is approximately 25%. Is this piece of information good news or a bad news for the profitability of the project?
Part II intro + questions
Before making the final decision, it is necessary to measure the risk, the risk premium, and the cost of capital more accurately.
This formal approach is worth doing because the EU Financial Market is transparent and financial information are reliable.
Of course, you could buy some pieces of information from financial agencies which publish financial data such as the beta, which is the key variable to measuring the risk premium.
However the access cost to such a financial data base is very expensive.
Using the same methodology as BLOOMBERG, you can evaluate your own BETA, based on the stock prices of FMI Company.
This French Company is quoted on the Paris Stock Exchange. 60 Monthly data
Stock prices of FMI, Market Index level, and 3 month Euribor, are available in the Data base: Monthly DATA
1- What is your computed BETA?
2- Given this BETA what should be the theoretical cost of capital?
3- What would your conclusions be?
6. Elmdale Enterprises is deciding whether to expand its production facilities. Although long term cash flows are difficult to estimate, management has projected the following cash flows for the first two years (in millions of dollars):
Year 1 year 2
Revenues 125 160
Cost of goods sold and operating
Expenses other than depreciation 40 60
Depreciation 25 36
Increase in working capital 5 8
Capital expenditures 30 40
Marginal Corporate tax rate 35% 35%
a. What are the incremental earnings for this project for years 1 and 2?
b. What are the free cash flows for this project for this first two years?
9. Markov manufacturing recently spent $15 million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is 35%. The company plans to use straight -line depreciation.
a. What is the annual depreciation expense associated with this equipment?
b. What is the annual depreciation tax shield?
c. Rather than straight-line depreciation, suppose Markov will use the MACRS depreciation method for five years property. Calculate the depreciation tax shield each year for this equipment under this accelerated depreciation schedule.
d. If Markov has a choice between straight line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which should it choose? Why?
e. How might your answer to part (d) change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?
File is attached with all questions I need help with.
Thank you SO much for helping me get started…
1) you are considering opening a new plant. The plant will cost $100 upfront and will take a year to build.
after that, it is expected to produce profits of $30 million at the end of every year of production.
The cash flows are expected to last forever.
Calculate the NPV of this investment opportunity if your cost of capital is 8%.
should you make the investment?
Calculate the IRR and use it to determine the maximum deviation allowable in the cost of the capital estimate to leave the decision unchanged.
2)Innovation Company is thinking about marketing a new software product. Upfront costs to market and develop the product are $5 million.
The product is expected to generate profits of $1million per year for ten years. The company will have to provide product support that will cost $100,000 per year in perpetuity.
Assume all profits and expenses occur at the end of the year.
a) what is the NPV of this investment if cost of capital is 6%? Should the firm undertake the project? Repeat the analysis for discount rates of 2% and 11%.
b) How many IRRs does this investment opportunity have?
c) What does the IRR rule indicate about this investment?
3) You work for an outdoor play structure mftg company and are trying to decide between 2 projects.
Year-End Cash Flows in ($) thousands
Project 0 1 2 IRR
Playhouse -30 15 20 10.40%
Fort -80 39 52 8.60%
You can undertake only 1 project. If your cost of capital is 8%, use the incremental IRR rule to make the correct decision.
4)
Home Builder Supply operates seven retail outlets in Georgia and South Carolina. Management is contemplationg building an eighth retail store across town from its most succesful retail outlet
The company already owns the land for this store, which currently has an abandoned warehouse located on it.
Last month, the marketing dept spent $10,000 on market research to determine the extent of customer demand for new store. Now Home Builder Supply must decide whether to build and open new store.
Which of the following should be included as part of the incremental earnings for the proposed new retail store?
a) cost of land where store will be located
b)cost of demolishing abandoned warehouse and clearing lot
c)loss of sales in the existing retail outlet, if customers who previously drove across town to shope at existing outlet become customers of new store instead.
d)the $10,000 in market research spent to evaluate customer demand
e)Construction costs for new store
f)Value of land if sold
g)Interest expense on debt borrowed to pay construction costs.
5)Elmdale Enteprises is deciding whether to expand its production facilities Although long term cash flows are difficult to estimate, management has projected the following cash flows for the first two years (in millions of $)
Year 1 Year 2
Revenues 125 160
Cost of goods and operatin expenses other than depreciation 40 60
Depreciation 25 36
Increase in working capital 5 8
Capital expenditures 30 40
Marginal corporate tax rate 35% 35%
a)What are the incremental earnings for this project for years 1 and 2?
b) What are the free cash flows for this project for first 2 years?
6)
Markov Mftg recently spent $15 million to purchase some equipment used in the manufacture of disk drives.
The firm expects that this equipment will have a useful life of 5 years and its marginal corporate tax rate is 35%.
The company pans to use straight line depreciation.
a)What is the annual depreciation expense associated with this equipment?
b)What is the annual depreciation tax yield?
c) Rather than straight-line, supposes Markov uses MACRS depreciation method for five-year property.
Calculate the depreciation tax shield each year for this eqpmt under this accerelated depreciation schedule.
d) If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected
to remain constant ,which should it choose? Why?
Batteries Inc. is considering developing a new long life battery for cell phones. You can invest immediately and start production right away.
Research effort cost $1m, marketing effort cost $0.5m (these are sunk costs)
Production equipment cost $1m and will have a useful life of 5 yrs and will depreciate using the straight line method. At year 4 you believe you can sell the equipment for $0.3m
Net working capital will increase by $1m immediately and be recaptured at year 4.
There are 2 separate customer bases for the batteries:
1) New cell phones- for every new cell phone, one battery will be used. Internal transfer price is $2 now and variable cost per battery to produce is 50 cents.
Production of new cell phone batteries will be 300,000 in first yr and will increase by 10% per year.
2) Existing cell phones- wholesale price is $10 per battery now and variable cost per battery is 50 cents.
Demand for existing cell phone batteries is 1m in first year and will increase by 10% per year. Out of the demand for batteries for the exiting cell phones this company expects to capture 80%.
Battery price and cost will rise 2% above inflation rate. Marketing & admin. fees will cost $0.5m first yr and rise at inflation each year after. Inflation will remain constant at 3%. Tax rate is 34%. Discount rate is 15%.
Please calculate company’s payback period, accounting rate of return, NPV and profitability index and show the formula.
2) Your firm has an opportunity to make an investment of $50,000. Its cost of capital (interest rate) is 12 percent. It expects after-tax cash flows (including the tax shield from depreciation) for the next 5 years to be as follows:
Year 1 10,000
Year 2 20,000
Year 3 30,000
Year 4 20,000
Year 5 5,000
Hint: You can use the Present Value Table A. 1c in pages 552 and 553 of your text book.
2a) Calculate the NPV
2b) Calculate the IRR (to the nearest percent)
2c) State whether this project should be accepted or rejected.
The term “capital budgeting” refers to decisions
a. which are made in the short run.
b. which concern the spreading of expenditures over a period lasting less than one year.
c. where expenditures and receipts for a particular undertaking will continue over a relatively long period of time.
d. where a receipt of cash will occur simultaneously with an outflow of cash.
Why is Capital Budgeting an important technique for companies wishing to assess an investment in projects? Which technique would you recommend to management?
You are comparing two investment options. The cost to invest in either option is the same today. Both options provide you with $20,000 of income. Option A pays five annual payments of $4,000 each. Option B pays five annual payments starting with $8,000 the first year followed by four annual payments of $3,000 each. Which one of the following statements is correct given these two investment options?
A. Both options are of equal value given that they both provide $20,000 of income.
B. Option A has a higher present value than option B given any positive rate of return.
C. Option B has a higher present value than option A given any positive rate of return.
D. Option B has a lower future value at year 5 than option A given a zero rate of return.
Your company wants to invest in a new product. The marketing department provided you with the following data:
After-tax cash flows for new product
Year 1 2 3 4 5 6
Low Demand 100 100 100 100 100 100
High Demand 300 500 600 700 700 600
All the cash flows will be received at the end of the year (Ignore taxes and depreciation). The project will require an initial investment today of $1,200.
A. Standard NPV: Assume that there is a 50% chance of high demand and a 50% chance of low demand. Compute NPV if the project is carried through to the end of Year 6 regardless of the demand. The appropriate discount rate is 11%.
B. Real Options NPV: Using the information above, if the demand is low your company can abandon the project at the end of the first year and sell the equipment for $550 (includes all tax ramifications of the sale). Use the 11% discount rate to compute the NPV including the option to abandon the project if demand is low.
I was hoping you could help me out with the attached assignment.
Many thanks!
I am having trouble answering and figuring out these questions in excel format can you help me?
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%.
1.Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2.Calculate the Payback Period (P/B) and the NPV for the project.
3.Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
4.If the project required additional investment in land and building, how would this affect your decision? Explain.
Cannot use the MACRS method and Keep in mind that the “cost of capital” figure provided for you in your assignment should be used in your calculations for NPV, only!
The Business Situation
Greetings Inc. stores, as well as the Wall Décor division, have enjoyed healthy profitability during the last two years. Although the profit margin on prints is often thin, the volume of print sales has been substantial enough to generate 15% of Greetings’s store profits. In addition, the increased customer traffic resulting from the prints has generated significant additional sales of related non-print products. As a result, the company’s rate of return has exceeded the industry average during this two-year period. Greetings’s store managers likened the e-business leverage created by Wall Décor to a “high-octane” fuel to supercharge the stores’ profitability.
This high rate of return (ROI) was accomplished even though Wall Décor’s venture into e-business proved to cost more than originally budgeted. Why was it a profitable venture even though costs exceeded estimates? Greetings stores were able to generate a considerable volume of business for Wall Décor. This helped spread the high e-business operating costs, many of which were fixed, across many unframed and framed prints. This experience taught top management that maintaining an e-business structure and making this business model successful are very expensive and require substantial sales as well as careful monitoring of costs.
Wall Décor’s success gained widespread industry recognition. The business press documented Wall Décor’s approach to using information technology to increase profitability. The company’s CEO, Robert Burns, has become a frequent business-luncheon speaker on the topic of how to use information technology to offer a great product mix to the customer and increase shareholder value. From the outside looking in, all appears to be going very well for Greetings stores and Wall Décor.
However, the sun is not shining as brightly on the inside at Greetings. The mall stores that compete with Greetings have begun to offer prints at very competitive prices. Although Greetings stores enjoyed a selling price advantage for a few years, the competition eventually responded, and now the pressure on selling price is as intense as ever. The pressure on the stores is heightened by the fact that the company’s recent success has led shareholders to expect the stores to generate an above-average rate of return. Mr. Burns is very concerned about how the stores and Wall Décor can continue on a path of continued growth.
Fortunately, more than a year ago, Mr. Burns anticipated that competitors would eventually find a way to match the selling price of prints. As a consequence, he formed a committee to explore ways to employ technology to further reduce costs and to increase revenues and profitability. The committee is comprised of store managers and staff members from the information technology, marketing, finance, and accounting departments. Early in the group’s discussion, the focus turned to the most expensive component of the existing business model?the large inventory of prints that Wall Décor has in its centralized warehouse. In addition, Wall Décor incurs substantial costs for shipping the prints from the centralized warehouse to customers across the country. Ordering and maintaining such a large inventory of prints consumes valuable resources.
One of the committee members suggested that the company should pursue a model that music stores have experimented with, where CDs are burned in the store from a master copy. This saves the music store the cost of maintaining a large inventory and increases its ability to expand its music offerings. It virtually guarantees that the store can always provide the CDs requested by customers.
Applying this idea to prints, the committee decided that each Greetings store could invest in an expensive color printer connected to its online ordering system. This printer would generate the new prints. Wall Décor would have to pay a royalty on a per print basis. However, this approach does offer certain advantages. First, it would eliminate all ordering and inventory maintenance costs related to the prints. Second, shrinkage from lost and stolen prints would be reduced. Finally, by reducing the cost of prints for Wall Décor, the cost of prints to Greetings stores would decrease, thus allowing the stores to sell prints at a lower price than competitors. The stores are very interested in this option because it enables them to maintain their current customers and to sell prints to an even wider set of customers at a potentially lower cost. A new set of customers means even greater related sales and profits.
As the accounting/finance expert on the team, you have been asked to perform a financial analysis of this proposal. The team has collected the information presented in Illustration CA 4-1.
Illustration CA 4-1 Information about the proposed capital investment project
cost of equipment(zero residual value) : $ 800,000
cost of ink and paper supplies (purchase immediately) : $ 100,000
Annual cash flow savings for wall decor : $ 175,000
annual additional store cash flow from increased sales : $ 100,000
sale of ink and paper supplies at end of 5 years: $ 50,000
expected life of equipment : 5 years
cost of capital : 12%
Exercises
Instructions
Mr. Burns has asked you to do the following as part of your analysis of the capital investment project.
1 Calculate the net present value using the numbers provided. Assume that annual cash flows occur at the end of the year.
2 Mr. Burns is concerned that the original estimates may be too optimistic. He has suggested that you do a sensitivity analysis assuming all costs are 10% higher than expected and that all inflows are 10% less than expected.
3 Identify possible flaws in the numbers or assumptions used in the analysis, and identify the risk(s) associated with purchasing the equipment.
4 In a one-page memo, provide a recommendation based on the above analysis. Include in this memo: (a) a challenge to store and Wall Décor management and (b) a suggestion on how Greetings stores could use the computer connection for related sales.
Tracy Turner, EVP of Like Magic, has called a meeting to discuss alternatives for the new computer system Like Magic has decided to purchase for order processing, inventory control, production scheduling, and sales forecasting. Like Magic plans to install the new computer system by the end of the year.
You summarize the important factors for the two computer systems being considered. The first choice is a system to handle the above applications and run the accounting applications currently being processed on a system Like Magic owns. With this choice, the existing system will be sold. The company plans to use the new system for 5 years, then replace it with advanced equipment. Fidel Fernandez, Purchasing Director, has obtained quotes for the hardware, software, and facilities of $180,000. He estimates this new equipment might be able to be sold for $36,000 after 5 years, but he has little confidence in that estimate. He also obtained a quote of $15,000 for the current system. You respond that the current system has a book value of $25,000, and therefore the resale would result in a loss. The company has decided that it will outsource operation of the new system. The cost of outsourcing will be $110,000 per year.
The second choice is to continue to run the accounting applications on the current equipment and buy a smaller system to run the new applications. If this choice is made, both the current and the new systems would be used for 5 years and then both would be replaced. Fidel estimates that the cost of this new system would be $90,000, and its resale value would be $18,000 after 5 years, but he also has little confidence in that amount. The current system will be fully depreciated in 2 years. The company estimates that outsourcing the operations of both systems will cost $125,000 for each of the next 2 years and $142,000 for years 3 through 5.
You decide to develop a spreadsheet model on your computer to help evaluate this decision. You will use both the NPV method and the IRR method in your calculations. You realize that the firm’s cost of capital is 16% so therefore you choose to use this rate as the required rate.
REQUIRED:
DETERMINE BOTH THE NET PRESENT VALUE AND THE IRR FOR BOTH ALTERNATIVES.
WHICH ALTERNATIVE DO YOU RECOMMEND?
DISCUSS THE POTENTIAL EFFECTS OF INFLATION ESPECIALLY IF THE COMPANY DID NOT GET A GUARANTEED COST IN ITS OUTSOURCING AGREEMENT.
Please show all work. Excel can also be used.
1. Innovation Company is thinking about marketing a new software product. Upfront costs to market and develop the product are $5 million. The product is expected to generate profits of $1 million per year for ten years. The company will have to provide support expected to cost $100,000 per year in perpetuity. Assume all profits and expenses occur at the end of the year.
a. What is the NPV of this investment if the cost of capital is 6%? Should the firm undertake the project? Repeat the analysis and discount the rates of 2% and 11%.
b. How many IRRs does this investment have?
c. What does the IRR indicate about this investment?
2. You work for an outdoor play structure manufacturing company and are trying to decide between two projects:
Year -End Cash Flows ($ thousands)
Project 0 1 2 IRR
Playhouse -30 15 20 10.4%
Fort -80 39 52 8.6%
You can undertake only one project. If the cost of capital is 8%, use the incremental IRR rule to make the correct decision.
3. Elm dale Enterprises is deciding whether to expand its production facilities. Although long-term cash flows are difficult to estimate, management has projected the following cash flows for the first two years (in millions of dollars)
Year 1 Year 2
Revenues 125 160
Cost of goods sold and operating
Expenses other than depreciation 40 60
Depreciation 25 36
Increase in working capital 5 8
Capital Expenditures 30 40
Marginal corporate tax rate 35% 35%
a. What are the incremental earnings for this project for years 1 and 2?
b. What are the free cash flows for this project for the first two weeks?
Markov Manufacturing recently spent $15 million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is 35%. The company plans to use straight-line depreciation.
a. What is the annual depreciation expense associated with this equipment?
b. What is the annual depreciation tax shield?
c. Rather than straight-line depreciation, suppose Markov will the MACRS depreciation methods for five year property. Calculate the depreciation tax shield for each year for this equipment under the accelerated depreciation schedule.
d. If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which should it choose? Why?
e. How might your answer to part (d) change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years.
If the NPV of a project with conventional cash flow is $500 and the required rate of return is 8%, the IRR must be:
A) equal to $500
B) Less than 8%
C) equal to 8%
d) greater than 8%
e) not enough information provided to accurately choose one of the answers above
Suppose Projects A and B have the Co and C1 after tax net cash flows shown below.
The Net Present Value Profiles for Project’s A and B will cross over one another at what approximate discount rate?
Project Co C1
A -500 +700
B -1000 +1300
A) 0 %
B) 10%
C) 16.67%
D) 20%
E) 21.37%
F) No crossover rate exists. The profiles never intersect.
G) The crossover cannot be determined from the information provided
Which one of the following investment techniques may not use all possible cash flows in its calculations?
A) NPV
B) Payback Period
C) IRR
D) PI
E) MIRR
E) Two or more of the above may NOT include all possible cash flows in their calculations
Determining NPV and 8 year forward rate.
Capital Budgeting and Financing.
Cantoon Co. is considering the acquisition of a unit for the French government. Its intial outlay would be $4 million. It will reinvest all the earnings in the unit. It expects that at the end of 8 years, it will sell the unit for 12 million euros after capital gains taxes are paid. The spot rate of the euro is $1.20 and is used as the forecast of the euro in the future years. Cantoon has no plans to hedge its exposure to exchange rate risk. The annualized U.S. risk-free interest rate is 5 percent regardless of the maturity of the debt, and the annualized risk-free interest rate on euros is 7 percent, regardless of the maturity of the debt. Assume that interest rate parity exists. Cantoon’s cost of capital is 20 percent. It plans to use cash to make the acquisition.
a) Determine the NPV under these conditions.
b) Rather than use all cash, Cantoon could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay a lump-sum total of 7 million euros at the end of 8 years to repay the loan. There are not interest payments on the debt. The way in which this financing deal is structured, none of the payment is tax deductible. Determine the NPV if Cantoon uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition. You need to derive the 8 year forward rate for this
Please see the attached questions that I need assistance with.
1. Carry & Co. is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past months were Project 263 and 264. The basis variables surrounding each project analysis, using the IRR decision technique, and the resulting decision actions are summarized in the following table.
Basic Variables Project 263 Project 264
Cost $64,000 $58,000
Life 15 years 15 years
IRR 8% 15%
Least-cost financing
Source Debt Equity
Cost (after-tax) 7% 16%
Decision
Action Accept Reject
Reason 8% IRR > 7% cost 15% IRR < 16% cost
a. Evaluate the firm’s decision-making procedures, and explain why the acceptance of Project 263 and rejection of Project 264 may not be in the owner’s best interest.
b. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table.
c. If the firm had used the weighted average cost calculated in part b, what actions would have been indicated relative to projects 263 and 264.
d. Compare and contrast the firm’s actions with your findings in part c. Which decision method seems more appropriate? Explain why.
2. Dennis Corporation has compiled the information shown in the following table.
Source of Capital Book Value Market Value After-Tax Cost
Long-term debt $4,000,000 $3,840,000 6.0%
Preferred stock 40,000 60,000 13.0
Common stock equity 1,060,000 3,000,000 17.0
Totals $5,100,000 $6,900,000
a. Calculate the weighted average cost of capital using book value weights.
b. Calculate the weighted average cost of capital using market value weights.
c. Compare the answers obtained in parts a and b. Explain the differences.
Please show work and post finished product in word.
ACG420 Unit 5 IP
Deer Valley Lodge, a ski resort in the Wasatch Mountains of Utah, has plans to eventually add five new chairlifts. Suppose that one lift costs $2 million, and preparing the slope and installing the lift costs another $1.3 million. The lift will allow 300 additional skiers on the slopes, but there are only 40 days a year when the extra capacity will be needed. (Assume that Deer park will sell all 300 lift tickets on those 40 days.) Running the new lift will cost $500 a day for the entire 200 days the lodge is open. Assume that the lift tickets at Deer Valley cost $55 a day. The new lift has an economic life of 20 years.
1. Assume that the before-tax required rate of return for Deer Valley is 14%. Compute the before-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
2. Assume that the after-tax required rate of return for Deer Valley is 8%, the income tax rate is 40%, and the MACRS recovery period is 10 years. Compute the after-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be a profitable investment. Show calculations to support your answer.
3. What subjective factors would affect the investment decision?
Project P, the firm is considering sponsoring a pavilion at the upcoming World’s fair. The pavilion would cost $800,000 and it is expected to result in $5million o incremental cash inflows during its 1 year of operation. However, it would then take another year, and $5million of cost, to demolish the sit and return it to its original condition. Thus, Project P’s expected cash flows look like this (in millions of dollars)
0 1 2
– $0.8 $5.0 -$5.0
The project is estimated to be of average risk, so its WACC is 10%.
(1) What is Project P’s NPV? What is its IRR? Its MIRR?
(2) Draw project P’s NPV profile. Does project P have normal or non-normal cash flows? Should this project be accepted? Explain.
(3) What is the difference between the regular and discounted payback methods?
(4) What are the two main disadvantages of discounted payback? Is the payback method of any real usefulness in capital budgeting decisions? Explain.
(5) What is the underlying cause of ranking conflicts between NPV and IRR?
(6) What is the investment rate assumption? And how does it affect the NPV versus IRR conflict?
(7) Which method is best? Why?
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%.
Based on this information you are to complete the following tasks.
Prepare a statement showing the incremental cash flows for this project over an 8-year period.
Calculate the Payback Period (P/B) and the NPV for the project.
Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
If the project required additional investment in land and building, how would this affect your decision? Explain.
For more information on creating Excel Spreadsheets, please visit the Excel Lab.
Given the following project cash flows, identify the correct statement(s). The firm’s cost of capital is 15%.
Cash Flow
0 -50
1 150
2 75
3 -10
I. This project will have two IRRs.
II. The NPV of the project is $180.57.
III. The profitability index of the project is 2.61.
IV. The payback period of the project is 1.33.
a. I only
b. II only
c. II and III only
d. IV only
e. I and IV only
I am attempting these problems and the book is confusing me and it only shows examples of how to calculate these using a financial calculator and I do not have one, is there another way to solving these that someone can show me.
(NPV and shareholder wealth) Stockholders are surprised to learn that the firm has invested $43 million in a project that has an expected payoff of $8 million per year for six years. The project’s cost of capital is 12%.
a. What is the project’s NPV?
b. There are 3 million outstanding shares. What should be the direct impact of this investment on the per-share value of the common stock?
(Net investment outlay) The cost of a new machine is $70,000 plus an additional $8,000 for freight and setup costs. The old machine that is being replaced has a book value of $15,000 and can be sold for $7,000. An investment of $15,000 in working capital is also required. The marginal tax rate is 30%. What is the net investment outlay?
(EAC) The total present value of all costs associated with an asset over a seven-year life is
$73,285. If the asset has a cost of capital of 11%, what is the EAC of using this asset?
B6. (Investment criteria) Consider the cash flows for the two capital budgeting projects given
here. The cost of capital is 10%.
a. Calculate the NPV for both projects.
b. Calculate the IRR for both.
c. Calculate the PI for both.
d. Calculate the MIRR for both.
e. Calculate the payback for both.
f. Which is the better project? Why?
YEAR 0 1 2 3 4
Project A −25,000 10,000 10,000 10,000 10,000
Project B −12,500 5,000 5,000 5,000 5,000
ABC Inc. is considering investing in a new machine. If it purchases the machine, annual cash revenues will increase by $125,000 whereas annual cash expenses will increase by $70,000. The machine costs $85,000 and has a useful life of 5 years. The tax rate is 34% and ABC Inc desires a 20% rate of return. A) Compute the net present value of the investment, assuming straight-line depreciation. B) Compute the net present value of the investment, assuming a 5 year recovery period and MACRS depreciation. C) Is the machine an acceptable investment? Tables attached.
I have a company that has a 8 year project life. The project requires an initial investment of $300 million to construct building and purchase equipment, and $20 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. Salvage value of the fixed assets is $15 million. The number of units of the new product expected to be sold in the first year is 2,000,000 and the expected annual growth rate is 10%. Sales price= $300 per unit; variable cost= $220 per unit in the first year adjusted based on the estimated annualized inflation rate of 2.8%. Required net operating working capital (NOWC) is 12% of sales. Corporate tax rate = 40.48 %. The discount rate is a WACC of 7.67%
a) Compute the depreciation basis & annual depreciation of the new project using MACRS allowances
b) Estimate annual cash flows for the 8 years.
c) Draw a time line of cash flows.
d) Using WACC of 7.67 as the discount rate, compute (NPV, IRR, MIRR, PI, Payback, Discounted Payback) to analyze the new project.
c) Please perform a sensitivity analysis(in excel) for the effects of sales growth rate, cost of capital, unit costs, sales price on the estimated NPV or IRR in order to demonstrate the sensitivity of the model. Please perform a scenario on these variables.
Please determine whether this project should be accepted based on the WACC and NPV.
Graham Dodd, the controller of the New Economy Transport Company was evaluating a replacement of the Cynthia II, one of the boats NETCO used to push barges up and down the Mississippi and Ohio Rivers. The Cynthia II was carried on their books at a net value of only $30,000, but it could probably be sold ‘as is’ along with an extensive inventory of spare parts for $100,000. The book value of the spare parts inventory was $40,000.
The chief engineer had estimated the current annual operating costs of the Cynthia II as:
Fuel $450,000
Labor and Benefits 480,000
Maintenance 141,000
Other 110,000
Total $1,181,000
Cohn and Doyle, Inc., a Wisconsin shipyard, had approached Mr. Dodd with a new design incorporating a Kort nozzle, extensively automated navigation and power control systems, for a fixed price of $2,000,000, payable immediately. Estimated annual operating costs of the new boat would be:
Fuel $370,000
Labor and Benefits 330,000
Maintenance 70,000
Other 74,000
Total $844,000
Mr. Dodd thought that $100,000 would have to be spent immediately training the new boats crew to handle the more complex and sophisticated equipment. Also, Mr. Dodd thought that a new boat might be able to push a larger load on some route which would generate additional revenues, net of out-of-pocket costs, of $100,000 per year.
Assumptions
Make use of the following assumptions:
1. The new boat would be purchased immediately, t = 0.
2. The marginal tax rate is 34%.
3. Forecasted costs are constant in real dollars.
4. Sale price for the Cynthia II and parts is $100,000 in real terms.
5. The Cynthia II would be sold when the new boat was delivered.
6. Investments qualify for the 5-year ACRS class.
7. Revenues are unaffected by the investment decisions, with the exception of the additional revenue from the new boat.
8. The new boat’s forecast value at t = 16 is $400,000.
9. Initial tax shields increase cash flow next year (t = 1).
10. Full operations with the new tugboat begin next year (t = 1).
11. Operating costs are taken at the beginning of the period.
12. Additional revenues are received at the beginning of the period
13. Long-term expected inflation is 5%.
14. The nominal opportunity cost of capital is 19%.
Your company is thinking about acquiring another corporation. You have two choices: the cost of each choice is $250,000. You cannot spend more than that, so acquiring both corporations is not an options. The following are your critical data:
a. Corporation A:
1) revenues = 100K in year one, increasing by 10% each year.
2) Expenses – 20K in year one, increasing by 15% each year
3) Depreciation expense = 5K each year
4) Tax rate = 25%
5) Discount Rate = 10%
b. Corporation B:
Revenues = 150K iin year one, increasing by 8% each year
Expenses = 60K in year one, increasing by 10% in each year
3) Depreciation Expense = 10K each year
4) Tax Rate = 25%
Discount Rate = 11%
You must compute and analyze items a through h using a Microsoft Excel spreadsheet. Make sure all calculations can be seen in the background of the applicable spreadsheet cells.
c) a 5-year projected income statement
d) a 5-year projected case flow
e. Net present value
f. Internal rate of return
g. Payback period
h. Profitability Index
i. Discounted payback period
j. Modified internal rate of return
k. Based on items a through h, which company would you recommend acquiring?
See the attached file.
You have been asked to help a local company evaluate a major capital expenditure. The company is a new internet company and must buy a large computer system which will generate additional revenue. The company provides you with the following information:
(Table includes all the necessary information included in the attached file)
Requirements:
a. Write a letter to the president of the company explaining whether the company should acquire the computer system. Utilize both NPV and IRR. Assume that the initial $7,850,000 in annual revenues will grow at a 6% annual rate and that the initial $6,950,000 in annual expenses will grow at a 5% annual rate. The growth starts in year 2 from year 1, i.e. the revenue is year 2 is 8,321,000, etc.
b. Redo this analysis above using sum-of-years digits depreciation method. What happens to the results and would you change your recommendation?
IN CLASS PROBLEMS: Class let’s see if we can also apply the concepts in Chapter 12 to the following problems.
.
1) The capital budgeting director of Analytical Systems Inc. (ASI) is evaluating a new project that would decrease operating costs by $30,000 per year without affecting revenues. The project’s cost is $50,000. The project will be depreciated using the MACRS method over its 3-year class life. It will have a zero salvage value after 3 years. The marginal tax rate of ASI is 35 percent, and the project’s cost of capital is 12 percent. What is the project’s NPV?
.
.
2) Your firm has a marginal tax rate of 40 percent and a cost of capital of 14 percent. You are performing a capital budgeting analysis on a new project that will cost $500,000. The project is expected to have a useful life of 10 years, although its MACRS class life is only 5 years. The project is expected to increase the firm’s net income by $61,257 per year and to have a salvage value of $35,000 at the end of 10 years. What is the project’s NPV?
.
.
3) The Board of Directors of American Brewing is considering the acquisition of a new still. The still is priced at $600,000, but would require $60,000 in transportation costs and $40,000 for installation. The still has a useful life of 10 years, but will be depreciated over its 5 year MACRS life. It is expected to have a salvage value of $10,000 at the end of 10 years. The still would increase revenues by $120,000 per year and increase yearly operating costs by $20,000 per year. Additionally, the still would require a $30,000 increase in net working capital. The firm’s marginal tax rate is 40 percent, and the project’s cost of capital is 10 percent. What is the NPV of the still?
.
.
4) As financial vice president, you are evaluating a potential new project. The VP-manufacturing and VP-sales have provided the following real revenue, operating cost, and depreciation data, all sated in constant Year 0 dollars:
.
Year____________Revenue____________Cost_____________Depreciation
0_______________$0________________$90,000____________$0
1________________40,000____________10,000____________30,000
2________________40,000____________10,000____________30,000
3________________40,000____________10,000____________30,000
.
The cost of capital to the firm is 14 percent, including the current inflation premium. You estimate that the reported real costs will escalate by 10 percent per year over the project’s life, starting at t=0, while revenues will increase by only 5 percent per year. The firm’s marginal tax rate is 40 percent. The $90,000 cost in Year 0 is the net after-tax cost of the project, while the $40,000 annual revenues and $10,000 annual costs are before tax. The project has no salvage value and does not require a change in net working capital. What is the project’s NPV?
Questions 72-76 address a capital budgeting problem and are related, though there are assumptions made in sequential questions to avoid an initial error causing all subsequent responses to be in error.
Consider the following for questions 72-76: A new product is being considered by Stanton Corp. An outlay of $40,000 is required for equipment and an additional net working capital investment of $1000 is required. The project is expected to have a 4 year life and the equipment will be depreciated on a straight line basis (equal annual amount) to a $4,000 book value.
Producing the new product will reduce current manufacturing expenses by $5,000 annually and increase earnings (revenue) before depreciation and taxes by $6,000 annually. Stanton’s marginal tax rate is 40 percent. Stanton expects the equipment will have a market salvage value of $10,000 at the end of 4 years.
72 What is the total cost at time zero of accepting this project?
a. 40,000
b. 41,000
c. 30,000
d. 31,000
e. Insufficient information to answer
73 What is the depreciation each year over the machine’s 4 year life?
a. 9,000
b. 9,250
c. 10,000
d. 10,250
e. Insufficient information to answer.
74 Regardless of your answer to number 73 above, ASSUME DEPRECIATION = $8,000 per year. What is the project’s after-tax operating cash flow during years 1-4 from the machine?
A. 11,000
b. 3,000
c. 6,600
d. 14,600
e. 9,800
75 Assuming the equipment is sold for the expected $10,000 market salvage value at the end of its 4 year life, compute the after tax salvage value of the equipment. Note: this question addresses ONLY the after-tax salvage value, i.e., the after-tax cash flow from the sale of the equipment. This question does NOT address any other terminal year cash flows.
a. 4,000
b. 6,000
c. 7,600
d. 10,000
e. none of the above
76 Regardless of your answer to number 74 & 75 above, ASSUME the project’s after-tax operating cash flow during years 1-4 from the machine = $8,000 and the after tax salvage value = $7,000. What is the TOTAL cash flow expected from this project in the terminal year, including any initial investment amounts assumed to be recovered? Include all terminal year flows as well as the terminal year operating cash flow of 8,000 assumed.
a. 7,000
b. 8,000
c. 15,000
d. 16,000
e. none of the above
USE THE FOLLOWING DATA FOR THE NEXT EIGHT PROBLEMS:
.
The director of capital budgeting for Good Foods, Inc. has identified two mutually exclusive projects, L and S, with the following expected net cash flows:
.
…………………………Expected Net Cash Flows
Year………………..Project L………………Project S
0……………………($100)…………………($100)
1………………………..10……………………..70
2……………………….60……………………..50
3……………………….80……………………..20
.
Both projects have a cost of capital of 10 percent.
.
1. What is the payback period for Project S?
.
2. What is Project L’s NPV?
.
3. What is Project L’s IRR?
.
4. What is Project L’s PI?
.
5. What is Project S’s PI?
.
6. What is Project L’s MIRR?
7. What is Project S’s MIRR?
.
8. What is the crossover point? (HINT: To find the precise crossover point, determine the cash flows for the Delta Project, which is the difference between the two projects’ cash flows (e.g., Project L minus Project S), then calculate IRR of Delta Project.) An alternate way to derive an approximate crossover point is to plot the NPV profiles for the two projects?
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.
1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2. Calculate the Payback Period (P/B) and the NPV for the project.
7) X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
Year Project A Project B
1 $12,000 $10,000
2 8,000 6,000
3 6,000 16,000
a) Which of the two projects should be chosen based on the payback method?
b) Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.
c) Should a firm normally have more confidence in answer a or b?
15) The Danforth Tire Company is considering the purchase of a new machine that would increase the speed of manufacturing and save money. The net cost of this machine is $66,000. The annual cash flows have the following projections:
Year Cash Flow
1 $21,000
2 29,000
3 36,000
4 16,000
5 8,000
a) If the cost of the capital is 10 percent, what is the net present value?
b) What is the rate of return?
c) Should the project be accepted? Why?
20) Miller Electronics is considering two new investments. Project C calls for the purchase of a coolant recovery system. Project H represents an investment in a heat recovery system. The firm wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:
Project C Project H
$25,000 Investment $25,000 Investment
Year Cash Flow Year Cash Flow
1 $6,000 1 $20,000
2 7,000 2 6,000
3 9,000 3 5,000
4 13,000
a) Determine the net present value of the projects based on a zero discount rate.
b) Determine the net present value of the projects based on a 9 percent discount rate.
c) The internal rate of return on Project C is 13.01 percent, and the internal rate of return on Project H is 15.68 percent. Graph a net present value profile for the two investments similar to figure 12-3. (Use a scale up to $10,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)
d) If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of the capital (discount rate) is 8 percent/ (Use the net present value profile for your decision; no actual numbers are necessary.)
e) If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would your decision be if the cost of capital is (1) 5 percent, (2) 13 percent, (3) 19 percent? Use the net present value profile for your answer.
Please help! I need assistance with the following three questions in the spreadsheet attached.
At he end of 2005, Uma Corporation was considering undertaking a major long-term project in an effort to remain competitive in its industry. The production
and sales departments determined the potential annual cash flow savings that could accrue to he firm if it acts soon. Specifically, they estimate that a mixed stream of future
cash flow savings will occur at the end of the years 2006 through 2011. The years 2012 through 2016 will see consecutive and equal cash flow savings at the end
of each year. The firm estimates that its discount rate over the first 6 years will be 7%. The expected discount rate over the years 2012 through 20156 will be 11%
The project managers will find the project acceptable if it results in present cash flow savings of at least $860,000. The following data is available to assist you:
a) Determine the value – at the beginning of 2006 – of the future cash flow savings expected to be generated by this project.
b) Should the firm undertake this project? Why or why not?
Uma Corp.
Present Value of Expected Future Savings
Period: 2006 through 2016
Discount rate for years 2006 – 2011 7%
Discount rate for years 2012 – 2016 11%
Annual Present
Year Period Savings PVIF PVIFA PVIF Value
2006 1 $110,000
2007 2 120,000
2008 3 130,000
2009 4 150,000
2010 5 160,000
2011 6 150,000
2012 7 90,000
2013 8 90,000
2014 9 90,000
2015 10 90,000
2016 11 90,000
$1,270,000 $-
10.2 Net present value: Kingston, Inc., is looking to add a new machine at a cost of $4,133,250. The company expects this equipment will lead to cash flows of $814,322, $863,275, $937,250, $1,017,112, $1,212,960, and $1,225,000 over the next six years. If the appropriate discount rate is 15 percent, what is the NPV of this investment?
10.5 Payback: Quebec, Inc., is purchasing machinery at a cost of $3,768,966. The company expects, as a result, cash flows of $979,225, $1,158,886, and $1,881,497 over the next three years. What is the payback period?
10.24 Draconian Measures, Inc., is evaluating two independent projects. The company uses a 13.8 percent discount rate for such projects. Cost and cash flows are shown in the table. What are the NPVs of the two projects?
Year
Project 1
Project 2
0
$(8,425,375)
$(11,368,000)
1
$3,225,997
$2,112,589
2
$1,775,882
$3,787,552
3
$1,375,112
$3,125,650
4
$1,176,558
$4,115,899
5
$1,212,645
$4,556,424
6
$1,582,156
7
$1,365,882
10.28 Jekyll & Hyde Corp. is evaluating two mutually exclusive projects. Their cost of capital is 15 percent. Costs and cash flows are given in the following table. Which project should be accepted? You only have to make the comparison using NPV, don’t bother with IRR.
Year
Project 1
Project 2
0
$(1,250,000)
$(1,250,000)
1
$250,000
$350,000
2
$350,000
$350,000
3
$450,000
$350,000
4
$500,000
$350,000
5
$750,000
$350,000
I am evaluating a proposed acquisition of a new computer for my company. The computer’s price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm’s before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for $25,000. The firm’s marginal tax rate is 40 percent, and the project’s cost of capital is 14 percent.
1) What is the net investment required at t = 0?
2) What is the operating cash flow in Year 2?
3) What is the total value of the terminal year non-operating cash flows at the end of Year 3?
4) What is the project’s NPV?
A ski resort plans to eventually add five new chairlifts. One lift costs $2 million, preparing slope costs another $1.3 million. The lift allows 300 additional skiers ,but there are only 40 days a year when the extra capacity will be needed. (The resort sell alls 300 lift tickets on those 40 days.) Running the new lift will cost $500 a day for the entire 200 days the lodge is open. Assume that the lift tickets at Deer Valley cost $55 a day and the added cash expenses for each skier-day are $5. The new lift has an economic life of 20 years. The before-tax required rate of return for the resort. Compute the before-tax NPV of the new lift and advise the managers of th resort the lift will be a profitable investment.
What is Capital Budgeting, and how is it utilized? Are you able to utilize this concept at home, and if so, in what ways?
1. The budget committee has received the following projects. They are mutually exclusive. The Company uses 10% as the rate of return.
Year Project A Project B
0 – 30,000 – 60,000
1 10,000 20,000
2 10,000 20,000
3 10,000 20,000
4 10,000 20,000
5 10,000 20,000
Total +20,000 + 40,000
NPV: +7,910 +15,820
Payback (Solve)
Which project would you recommend first and why?
The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $150,000 with a disposal value of $40,000 and would be able to produce 5,000,000 cans over the life of the machinery. The production department estimates that approximately 1,000,000 cans would be needed for each of the next five years.
In addition to the purchase cost of the equipment, $12,000 would be needed to train three new employees in the production process. These three individuals would be full-time employees working 2,000 hours per year and earning $10.00 per hour. They would also receive the same benefits as other production employees, 18% of wages in addition to $2,200 of health benefits.
It is estimated that the raw materials will cost 30¢ per can and that other variable costs would be 4¢ per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.
It is expected that cans would cost 50¢ per can if purchased from the current supplier. The company’s minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint as well as number of units sold will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased.
1. Based on the above information and using Excel, calculate the following items for this proposed equipment purchase:
Annual cash flows over the expected life of the equipment
Payback period
Annual rate of return
Net present value
Internal rate of return
2. Would you recommend the acceptance of this proposal? Why or why not. Prepare a short double spaced Word paper elaborating and supporting your answer.
Roethlis Partners has compiled the following data for a potential venture:
Investment: $20,000; 5-year useful life, with no salvage value;
Annual Sales Revenue = $10,000; Annual Cash Costs = $4,200
Roethlis imposes a required rate of return of 10%. Roethlis faces a 20% tax rate on income, and knows that the tax authorities will only permit straight line depreciation for tax purposes.
a. Is this a project Roethlis would benefit from taking on?
b. Suppose that Roethlis uses straight line depreciation for internal accounting. Demonstrate the conservation property of residual income in this setting, and also show that strict goal congruence is not achieved.
c. For internal purposes alone, suppose that Roethlis switches to a schedule whereby depreciation charges increase over time at a compound rate of 10% (the cost of capital). Compute the depreciation amounts under this plan and show that they lead to strict goal congruence.
(Hints: For internal purposes, let income equal after-tax cash flows (less) depreciation. Note that the proposed depreciation schedule affects the depreciation amounts, net book values and, as a result, the capital charges; however, it has no impact on cash taxes paid, or cash flows in general).
1) Simpson corporation is considering a proposed expansion to its facilities. Which of the following statements is most correct?
a. In calculating the project’s operating cash flows, the firm should not subtract out financing costs such as interest expense, since these costs are already included in the WACC, which is used to discount the project?s net cash flows.
b. Since depreciation is a non-cash expense, the firm does not need to know the depreciation rate when calculating the operating cash flows.
c. When estimating the project?s operating cash flows, it is important to include any opportunity costs and sunk costs, but the firm should ignore cash flows from externalities since they are accounted for elsewhere.
d. Statements a and c are correct.
e. None of the statements above is correct
2) Which of the following statements is correct?
a. Well-diversified stockholders do not consider corporate risk when determining required rates of return.
b. Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk.
c. Empirical studies of the determinants of required rates of return (k) have found that only market risk affects stock prices.
d. Market risk is important but does not have a direct effect on stock price because it only affects beta.
e. All of the statements above are correct.
3) Simpson corporation is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should
a. Increase the IRR of the asset to reflect the greater risk.
b. Increase the NPV of the asset to reflect the greater risk.
c. Reject the asset, since its acceptance would increase the firm?s risk.
d. Ignore the risk differential, if the asset to be accepted would comprise only a small fraction of the firm?s total assets.
e. Increase the cost of capital used to evaluate the project to reflect the project?s higher risk.
1) Thompson corp has proposed project with normal cash flows. In other words, there is an up-front cost followed over time by a series of positive cash flows. The projects internal rate of return is 12 percent and its WACC is 10 percent. Which of the following statements is most correct?
a. The projects NPV is positive.
b. The project?s MIRR is greater than 10 percent but less than 12 percent.
c. The projects payback period is greater than its discounted payback period.
d. Statements a and b are correct.
e. All of the statements above are correct
2) Stock C has a beta of 1.2, while Stock D has a beta of 1.6. Assume that the stock market is efficient. Which of the following statements is most correct?
a. The required rates of return of the two stocks should be the same.
b. The expected rates of return of the two stocks should be the same.
c. Each stock should have a required rate of return equal to zero.
d. The NPV of each stock should equal its expected return.
e. The NPV of each stock should equal zero.
In essence, capital budgeting is the process of:
a. Deciding what to do with the firmâ??s money
b. Deciding how much capital the firm needs
c. Deciding where to get the money for capital investment projects
d. Deciding when to invest in a new project
Which of the following cash flows is an â??incremental cash flowâ? for the purposes of capital budgeting?
a. Expenditures on plant and equipment for a new project
b. R& D expenditures for a new project during the last three years
c. Dividend payments
d. Reduction of a competitorâ??s sales as a result of the your companyâ??s introduction of a new product
In capital budgeting, the payback period is the:
a. Amount of time it takes to receive all the future cash flows from a project
b. Amount of time it takes to pay back any money borrowed to finance the project
c. Amount of time it take for the project to be completed
d. Amount if time it takes to recoup the initial investment for the project
1) Tom Thurlow wants to buy a boat but is short of cash. Two alternatives are available: Tom can accept $2,000 per year from his brother for partial ownership in the boat, or he can earn money by renting the boat to others. Rental income would be $2,500 per year. Under either alternative, the boat will last eight years. If Tom rents the boat out, he will have to pay $3,000 to overhaul the engine at the end of the fourth year.
Which alternative should Tom select, assuming that the cost of capital is 12% and that only quantitative considerations are involved?
2) Net Present Value Used to Rank Alternatives
Taglioni’s Pizza Company has to choose a new delivery car from among three alternatives. Assume that gasoline costs $1.30 per gallon and that the firm’s cost of capital is 12%. The car will be driven 12,000 miles per year.
Car 1 Car 2 Car 3
Cost 12,000 4,000 8,000
Mileage per gallon 40 8 12
Useful life 5 yrs 5yrs 5yrs
Salvage value 2,000 500 1,000
Required:
1. Which car should the company purchase?
2. How would your answer change if the price of gasoline increased to $2 per gallon?
The task is to calculate a capital budgeting for a new hotel (eco-hotel) in Ontario. Attached, you will find 4 excel files providing different statements (such as initial cost, depreciation, income statement, cash flow etc.), and there is few questions paste inside the attachment. And I will appreciate if you can solve the following question for me. Thx
1. The step to calc the capital budgeting
2. Anymore thing should I take consider?
3. Can u please correct it?
4. how should i analyze the capital structure?
Again, thanks a lot!!!! If there is any further information you need, pls feel free to contact me. thx
You are asked to analyse the following project:
Initial investment:
Equipment: $3,500,000
Initial net Working capital 10% of first year sales
Operating results
Year 1 Year 2 Year 3 Year 4 Year 5
$4,000,000 $5,000,000 $5,000,000 $5,500,000 $5,000,000
Variable costs: 60% of sales
Fixed costs: $500,000
Annual depreciation charge for equipment: $400,000
Investment in net working capital: 10% of next year increase in sales.
Taxes: 30%
Cost of capital: 10%
The project ends at the end of the 5th year. The net working capital is
recovered at the end of the project.
The net salvage value of assets at the end of the project is $1,500,000
Required:
a. Estimate the project’s cash flows
b. Using the payback period, the discounted payback period, the net present value and the profitability ratio, assess the project and present your conclusion.
The Ewert Company is evaluating the proposed acquisition of a new milling machine. The machine’s base price is $108,000 and it would cost another $12,500 to modify it for special use by the firm. The machine falls into MACRS 3-year class, and it would be sold after three years for $65,000 (See Table 13A.2 for MACRS recovery percentages – Table attached). The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs (mainly labor). Ewerts tax rate is 34 percent.
A)What is the initial investment outlay in Year 0 associated with this machine for capital budgeting purposes?
B)What are the incremental operating cash flows in Year 1, 2, and 3?
C)What is the terminal cash flow in Year 3?
D)If the projects required rate of return is 12 percent, should Ewert purchase the machine?
The accountant of your business has recently been taken ill through overwork. In his absence his assistant has prepared some calculations of the profitability of a project, which are to be discussed soon at the board meeting of your business. His workings, which are set out below, include some errors of principle. You can assume that the statement below includes no arithmetical errors.
plz see attachment
You ascertain the following additional information:
– the cost of equipment contains #100,000, being the carrying (balance sheet) value of an old machine. If it were not used for this project it would be scrapped with a zero net realisable value. New equipment costing #500,000 will be purchased on 31 Dec Year 0. You should assume that all other cash flows occur at the end of the year to which they relate.
– the development costs of #90,000 have already been spent
– Overheads have been costed at 50 per cent of direct labour, which is the business’s overheads are likely to amount to #30,000 a year.
– the business’s cost of capital is 12 per cent.
Ignore taxation in your answer.
Required:
(a) Prepare a corrected statement of the incremental cash flows arising from the project. Where you have altered the assistant’s figures you should attach a brief note explaining your alterations.
(b) Calculate:
(i) The project’s payback period
(ii) The project’s net present value as at 31 Dec Year 0
(c) Write a memo to the board advising on the acceptance or rejection of the project.
Your firm is considering the purchase of a machine tool automation system. Which of the following should you choose if your cost of capital is 15%? The life of both alternatives is 5 years. Why?
Acme Machine: Cost = $55,000
Maintenance Contract: $12000 annually
Baker Machine: Cost $39,000
Maintenance Contract: $21,000 annually
Need help completing yearly costs and answering Item V question D
See attached file for full problem description.
END OF YEAR 0 1 2 3
I. INVESTMENT OUTLAY
EQUIPMENT CST $200,000.00
INSTALLATION $40,000.00
INCREASE IN INVENTORY $25,000.00
INCREASE IN ACCOUNTS PAYABLE $5,000.00
TOTAL NET INVESTMENT $270,000.00
II. OPERATIONS CASH FLOW
UNIT SALES (THOUSANDS) 100 100 100
PRICE UNIT $2.00 $2.00 $2.00 $2.00
TOTAL REVENUES
OPERATING COSTS, EXCLUDING DEPRECIATION $30,000.00 $120,000.00
DEPRECIATION $240,000.00 $36.00
TOTAL COSTS $270,000.00 $199,200.00 $228,000.00
OPERATING INCOME BEFORE TAXES $270,000.00 $44,000.00
TAXES ON OPERATING INCOME $108,000.00 0.3
OPERATING INCOME AFTER TAXES $162,000.00 $26,400.00
DEPRECIATION $80,000.00 79,200 36,000
OPERATING CASH FLOW $82,000.00 $79,700.00
III. TERMINAL YEAR CASH FLOW
RETURN OF NET OPERATING WORKING CAPITAL
SALVAGE VALUE
TAX ON SALVAGE VALUE
TOTAL TERMINATION CASH FLOWS
IV. NET CASH FLOWS
NET CASH FLOW $(260,000.00) $89,700.00
V. RESULTS (QUESTION D.) no alternative use for the building over the next 4 years, npv, ipr, mirr, payback. Do these indicators suggest that the project shoulb be accepted?
NPV=
IPR=
MIRR=
PAYBACK=
Chloe Schwasher, the vp of Finance for a major appliance manufacture, has before her 8 investment proposals submitted by various segments of the company for her approval or rejection. the table below summarizes each proposal’s net present value (NPV)& capital requirements for the next 5 years. because of the limited cash availability not all proposal can be funded. Chloe’s objective is to maximize the total NPV of the proposals to be funded. Help Chloe make the decision by sending her a memo w/your recommendations along w/the appropriate STORM outputs. Oh by the way there are some other conditions:
a) Proposals 1,2 & 3 are alternatives for the proposed but not mandatory construction of a new manufacturing plant.
b) proposls 4, 5 & 6 are alternatives for a mandatory new advertising campaign.
c) proposals 7 involves the purchase of a new & more powerful computer, & proposal 8 involves the installation of a new computerized inventory control system. Further the approval of the proposed inventory system is contingent on the approval of the computer system.
( Proposal ($000)
1 2 3 4 5 6 7 8 Capital
NPV ($000)–>151 197 119 70 130 253 165 300 Available
Capital YR1 20 100 20 30 50 40 50 80 [230]
required YR2 20 10 10 30 10 20 40 30 [100] ($000) YR3 20 0 10 30 10 20 10 20 [50]
YR4 20 0 10 20 10 20 10 0 [50]
YR5 10 30 10 10 10 20 10 0 [50]
Note numbers in brackets are Capital Available ($000)
I know this is a maximization problem & I know there are 8 variables but I need the coefficients. Also need the constraints. I believe this is a mixed integer problem but I may be wrong. I am putting the info you give me into a cd-rom program that I will run to get an answer. Please give me the inputs and can you some how show the work involved? Please help me.
Capital budgeting is needed to properly allocate the large dollar amounts for major expansion and equipment purchases. The process is often perceived by employees as being very political. What procedures should an organization use to eliminate that perception and to provide for a good, consistent evaluation of capital projects?
Capital Budgeting Spreadsheet
Gardial Fisheries is considering two mutually exclusive investments. The projects’ expected net cash flows are as follows:
Expected net cash flows
Time Project A Project B
0 ($375) ($575)
1 ($300) $190
2 ($200) $190
3 ($100) $190
4 $600 $190
5 $600 $190
6 $926 $190
7 ($200) $0
a. If you were told that each project’s cost of capital was 12 percent, which project should be selected? If the cost of capital was 18 percent, what would be the proper choice?
@ a 12% cost of capital @ a 18% cost of capital
Use Excel’s NPV function as explained in “Ch 10 Tool Kit.xls”. Note that the range does not include the costs, which are added separately.
WACC = 12% WACC = 18%
NPV A = NPV A =
NPV B = NPV B =
At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%, then the choice is reversed, and Project B should be accepted.
b. Construct NPV profiles for Projects A and B.
Before we can graph the NPV profiles for these projects, we must create a data table of project NPV relative to differing costs of capital.
Project A Project B
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
26%
28%
30%
c. What is each project’s IRR?
We find the internal rate of return with Excel’s IRR function:
IRR A = Note in the graph above that the X-axis intercepts are equal to the two projects’ IRRs.
IRR B =
d. What is each project’s MIRR at a cost of capital of 12 percent? At r = 18%? (Hint: Consider Period 7 to be the end of Project B’s life.)
@ a 12% cost of capital @ a 18% cost of capital
MIRR A = MIRR A =
MIRR B = MIRR B =
e. What is the crossover rate, and what is its significance?
Cash flow
Time differential
0
1
2 Crossover rate =
3
4 The crossover rate represents the cost of capital at which the two projects
5 have the same net present value. In this scenario, that common net present
6 value, at a cost of capital of 13.13%, is:
7
f. What is the regular payback period for these two projects?
Project A
Time period: 0 1 2 3 4 5 6 7
Cash flow: (375) (300) (200) (100) 600 $600 $926 ($200)
Cumulative cash flow:
Logical test:
Max Row 93=Payback:
Payback: Alternative calculation using nested IF statements.
Project B
Time period: 0 1 2 3 4 5 6 7
Cash flow: (575) 190 190 190 190 $190 $190 $0
Cumulative cash flow:
Payback:
g. At a cost of capital of 12%, what is the discounted payback period for these two projects?
WACC = 12%
Project A
Time period: 0 1 2 3 4 5 6 7
Cash flow: (375) (300) (200) (100) 600 $600 $926 ($200)
Disc. cash flow:
Disc. cum. cash flow:
Discounted Payback:
Project B
Time period: 0 1 2 3 4 5 6 7
Cash flow: (575) 190 190 190 190 $190 $190 $0
Disc. cash flow:
Disc. cum. cash flow:
Discounted Payback:
The Best Manufacturing Company is considering a new investment. Financial projections for the investments are tabulated below. Cash flows are in $ thousands, and the corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating cost and income taxes are paid in cash, and all cash flows occurs at the end of the year
Year 0 Year 1 Year 2 Year 3 Year 4
Investment 10,000 – – – –
Sales revenue – 7,000 7.000 7,000 7,000
Operating cost – 2,000 2,000 2,000 2,000
Depreciation – 2,500 2,500 2,500 2,500
Net working 200 250 300 200 –
Capital (end of yr)
a. Compute the incremental net, income of the investment for each year.
b. Compute the incremental cash flows of the investment for each year.
c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?
Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 10 units per year at $0.3 million net cash flow per unit for the nest five years. The engineering department has come up with the estimate that developing the machine will take $10 million initial investment. The finance department has estimated that 25 percent discount rate should be used.
a. What is the base case NPV.
b. If unsuccessful, after the first year the project can be dismantled and sole for scrap for $5 million. Also, after the first year, expected cash flows will be revised up to 20 units per year or to 0 units, with equal probability, if so, what is the option value of abandonment? What is the revised NPV?
OTA, Please underline the final answer and display all calculations used to reach solution (Word not Excel). Thank you.
1. Hilton Hotels is planning to open a new hotel in Dubai at an initial investment of $20 million. It expects positive cash flows of $4 million a year at the end of each of the next 20 years. The project’s cost of capital is 15%.
A. What is the project’s net present value?
B. In year 1, Hilton Hotels will know if the government of Dubai will impose a large hotel tax. There is a 50 percent chance that it will not. If the tax is imposed, the yearly cash flows will only be $2.5 million; if not, the yearly cash flows will be $5.5 million. The initial investment of $20 million will be the same today or 1 year from now. Should Hilton Hotels go ahead with the project today or should it wait a year before deciding?
2. Provided below is information on a stock and its call option:
The price of the stock is $40.
The strike price is $40.
The option matures in 3 months (t=0.25).
The standard deviation of the stock’s returns is 0.40 and the variance is 0.16.
The risk-free rate is 6 percent.
An analyst is able to calculate some other necessary components of the Black-Scholes model:
d1 = 0.175
d2 = -0.025
N(d1) = 0.56946
N(d2) = 0.49003
A. Using the Black-Scholes model, what is the value of the call option?
B. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option?
3. A certain project has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital is 12 percent.
A. Compute its discounted payback period.
B. Compute its NPV.
C. Compute its IRR.
D. Compute its MIRR.
4. There are 2 alternative projects. Project 1 has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $30 million per year. Project 2 has a life of 10 years, will cost $132 million, and will produce net cash flows of $25 million per year. The company needs to plan for 10 years. Its cost of capital is 12 percent.
A. By how much would the value of the firm increase if it accepted the better project?
5. California Trucking Company purchased a new truck. It costs $22,500 and it is expected to generate net after-tax operating cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected salvage values after tax adjustments are provided below. The California Trucking Company’s cost of capital is 10 percent.
Year Annual Operating Cash Flow Salvage Value
0 ($22,500) $22,500
1 $6,250 $17,500
2 $6,250 $14,000
3 $6,250 $11,000
4 $6,250 $5,000
5 $6,250 0
A. Should California Trucking Company operate the truck until the end of its 5-year physical life, or, if not, what is its optimal economic life?
6. D.C. Company is assessing a proposed acquisition of a new machine Its base price is $70,000 and it would cost $15,000 to modify it for special use. It will be depreciated at the rate of 33% on the 1st year, 45% on the 2nd year, and 15% on the 3rd year. It will be sold after 3 years for $30,000. Its use will require an increase in net working capital of $4,000. It will have no effect on revenues however it is expected to save the company $25,000 per year in before-tax operating costs, mainly labor. The company’s marginal tax rate is 40 percent.
A. What is the net cost of the machine? (What is the Year 0 net cash flow?)
B. What are the net operating cash flows in Years 1, 2, and 3?
C. What is the additional (nonoperating) cash flow in Year 3?
D. If the project’s cost of capital is 10 percent, should the machine be bought?
7. Intel Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semi-annually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Its beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. It is a constant-growth company which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The company’s marginal tax rate is 40 percent.
A. What is its component cost of debt?
B. What is its cost of preferred stock?
C. What is its cost of common stock (rs) using the CAPM approach?
D. What is its cost of common stock (rs) using the DCF approach?
E. What is its WACC? (For cost of common stock, use either of your solutions to C. or D.?
Accounting – Relevant cash flows/NPO Terminal Value. See attached file for full problem description.
ABC Company is considering replacing an existing hoist with one of the two newer
more efficient pieces of equipment. The existing hosit is three years old, cost is
$32,000 and is being depreciated under MACRS using a 5 year recovery period.
It has a remaining economic lfie of 5 yrs. With no salvage value. The existing hoist
can currently be sold for $18,000.
Hoist A, one of the two possible replacement hosits, costs $40,000 to purchase and
$8,000 to install. It has a 5 hyr. Economic life and will be depreciated under MACRS
using a 5 yr. recovery period.
Hoist B costs $54,000 to install. It also has a 5 yr. economic life and will be
depreciated under MACRS using a 5 yr. recovery period.
The project Earnings before depreciatio, interest, and taxes for the existing and both
alternativ e hoists are:
EARNINGS BEFORE DEPRECIATION, INTEREST AND TAXES
Year Hoist A Hoist B Existing Hoist
1 21,000 22,000 14,000
2 21,000 24,000 14,000
3 21,000 26,000 14,000
4 21,000 26,000 14,000
5 21,000 26,000 14,000
ABC company is subject to a 40% tax rate for both capital gains and ordinary income.
Here are the questions relevant to the above problem.
a. Calculate the initial investment associated with each investment
b Calcula te incremental operating cash flows associated with each
alternative (be sure to consider the d epreciation in year-6)
c Calculate the NPV associated with each alternative, using a 12% discount rate
d Calculate the IRR associated with each alternative
e Calculate the payback associated with each alternative
f Made a very brief recommendation to the firms’ Board of Directors-
What should it do? And why?
Problem number 2
Relevant cash flows-Npo terminal value
CLAc is considering replacing an existing piece of machinery with a more sophisticated
machine. The old machine was purchased 3 years ago at a cost of $50,000 and this
amount was being depreciated under MACRS using a 5 yr. recovery period. The machine
has 5 years of usable life remaining. The new machine that is being consdiered costs
$76,000 and requires $4,000 in installation costs. The new machine would be depreciated
under MACRS using a 5 yr. recovery period. The firm can currently sell the old machine
for $55,000 without incurring any removal ro cleanup costs. The firm is subject to a tax
rate of 40%. The revenues and expenses (excluding depreciation and interest)
associated with the new and the old machines for the next 5 years. Are given in the table
below.
New Machine Old Machine
Year Revenue Expenses Revenue
(excl.depr.&int.
1 750,000 720,000 674,000
2 750,000 720,000 676,000
3 750,000 720,000 680,000
4 750,000 720,000 678,000
5 750,000 720,000 674,000
Based on above information:
1 compute the NPV assuming a 12% discount rate
2 Compute the IRR
3 Compute the Payback period
4 Would you invest in this project? Why/why not?
MACRS: modified accelerated cost recovery system
depreciation methods
NPV: Net Present Value
IRR: Internal Rate of Return
Payback Period: Is the amount of time required for the firm to recover its initial
investment in a project as calculated from cash inflows.
The payback period is generally viewed as an unsophisticated captial
budgeting technique, because it does not explicitly consider
the itme value of money.
Reto S.A.
In December 2004, R. E. Torgler was trying to decide whether to add a new line of injection
molded plastic products to those already manufactured and distributed by Reto S.A. In order to do
so, the firm would have to buy new injection molding equipment; none of the existing equipment
could be adapted to perform the necessary operations, and Torgler was anxious to retain control of
manufacturing. Actually, new injection molding equipment of the type needed had been considered
before, but a decision to purchase the equipment had been postponed because the product concept
was judged to need additional development. But now the products seemed ready.
Sales of the new product were forecast at SFr. 2,000,0001 per year, from which a sales commission
of 15 percent would be paid to Reto’s sales agents. Direct manufacturing costs were budgeted at SFr.
600,000 for materials and SFr. 900,000 for labor, leaving an annual cash flow before taxation of SFr.
200,000. The new equipment would cost SFr. 600,000, delivered and installed, and was expected to
have an economic life of 10 years before it would become worthless.
Reto was able to borrow money at 8 percent, although it did not plan to negotiate a loan
specifically for the purchase of this equipment.
Questions
1. Ignoring the effect of taxes, what is the “internal rate of return” (IRR) on the proposed
investment. Assume the new equipment would be installed by January 1, 2005, and begin
producing on that date.
2. The cost of the equipment can be deducted from annual cash flows before they are subjected
to taxation. Assuming that the equipment will last 10 years, and that an equal amount of the
cost of SFr. 600,000 will be deducted each year, and that the tax rate is expected to be 45
percent, what is the IRR on an after-tax basis?
3. Torgler has stated that Reto should be willing to purchase this machine as long as it yielded a
return of 12 percent after taxation. Should he make the investment?
1 Actual sales were made in several different currencies, but for simplicity here all money measurements are stated in their
Swiss franc equivalents. The approximate exchange rate at the time of writing the case was SFr. 1.30 = U.S. $1.00.
197-102 Reto S.A.
2
4. Actually, to stimulate industrial development, the tax rules allow up to one third of the cost of
any such investment to be deducted from cash flows in the first year after the investment, and
up to one-fifth of the remainder of the unamortized investment amount can be deducted in
the second year. Thereafter, annual deductions are computed on a straight-line basis such that
no more than the original cost of the equipment is depreciated over its economic life. How, if
at all, does this tax rule affect the attractiveness of the investment?
5. Reto has learned that investment in working capital (receivables and inventories, less
payables) amounts to approximately 15 percent of sales. Will the additional SFr 300,000
investment for the new line decrease the rate of return on investment to less than the 12
percent criterion Torgler has been using?
6. In late December 2004, Reto purchased the equipment, and the operating results turned out as
forecast. A year later, Torgler learned that the manufacturer of the equipment had introduced
new models which were more automated. The new equipment sold for SFr. 1,000,000 and
would permit labor savings of SFr. 200,000 per year, thus doubling the net operating cash flow
on the product. As a result of the technological advance, Torgler expected the one-year-old
machine could be sold for only SFr. 200,000 despite the fact that its book value was SFr.
400,000. If Reto buys the new machine and depreciates it using allowed tax depreciation over
10 years, would the investment meet the 12 percent after-tax criterion?
7. If the one-year-old machine had no salvage value at all, would replacing it with the new
machine still be desirable?
8. Torgler was loathe to throw away a nearly new machine and thought he might be better off to
keep it one more year and then replace it. Would he be better off? How would you go about
addressing this issue?
9. During 2005, the rate of inflation remained low, and it was expected that it would average
about 4 percent for the year. Torgler wondered how Reto’s analysis should reflect this rate of
inflation, which he expected might continue for several years. Advise Torgler on this issue.
After extensive research and development, Goodweek Tires, Inc., has recently developed a new
tire, the SuperTread, and must decide whether to make the investment necessary to produce and
market it. The tire would be ideal for drivers doing a large amount of wet weather and off-road
driving in addition to normal freeway usage. The research and development costs so far have
totaled about $10 million. The SuperTread would be put on the market beginning this year,
and Goodweek expects it to stay on the market for a total of four years. Test marketing costing
$5 million has shown that there is a significant market for a SuperTread-type tire.
As a financial analyst at Goodweek Tires, you have been asked by your CFO, Adam Smith,
to evaluate the SuperTread project and provide a recommendation on whether to go ahead with
the investment. Except for the initial investment that will occur immediately, assume all cash
flows will occur at year-end.
Goodweek must initially invest $120 million in production equipment to make the Super-
Tread. This equipment can be sold for $51 million at the end of four years. Goodweek intends
to sell the SuperTread to two distinct markets:
1. The original equipment manufacturer (OEM) market: The OEM market consists primarily
of the large automobile companies (like General Motors) that buy tires for new cars. In
the OEM market, the SuperTread is expected to sell for $36 per tire. The variable cost to
produce each tire is $18.
2. The replacement market: The replacement market consists of all tires purchased after the
automobile has left the factory. This market allows higher margins; Goodweek expects
to sell the SuperTread for $59 per tire there. Variable costs are the same as in the OEM
market.
Goodweek Tires intends to raise prices at 1 percent above the inflation rate; variable costs
will also increase at 1 percent above the inflation rate. In addition, the SuperTread project will
incur $25 million in marketing and general administration costs the first year. This cost is expected
to increase at the inflation rate in the subsequent years.
Goodweek’s corporate tax rate is 40 percent. Annual inflation is expected to remain constant
at 3.25 percent. The company uses a 15.9 percent discount rate to evaluate new product
decisions. Automotive industry analysts expect automobile manufacturers to produce 2 million
new cars this year and production to grow at 2.5 percent per year thereafter. Each new car
needs four tires (the spare tires are undersized and are in a different category). Goodweek Tires
expects the SuperTread to capture 11 percent of the OEM market.
Industry analysts estimate that the replacement tire market size will be 14 million tires this
year and that it will grow at 2 percent annually. Goodweek expects the SuperTread to capture an
8 percent market share.
The appropriate depreciation schedule for the equipment is the seven-year MACRS depreciation
schedule. The immediate initial working capital requirement is $11 million. Thereafter,
the net working capital requirements will be 15 percent of sales. What are the NPV, payback
period, discounted payback period, AAR, IRR, and PI on this project?
The TitMar Motor Company is considering the production of a new personal transportation vehicle that would be called the PTV.
The PTV would compete directly with the innovative new Segway. The PTV will utilize a three wheel platform capable of carrying one rider for up to 6 hours per battery charge, thatnk to a new battery system developed by TitMar.
TitMar’s PTV will sell for substentially less than the Segway but will offer equivalent features. The pro forma financials for the proposed PTV project, including forecasts and assumptionsthat underline them are set out in Exhibit P3-4.1.
Note that revenue is calculated as follows: price per unit * market share (%) * market size, and units sold = revenues / price per unit. The project offers an expected NPV of $9,526,209 and an IRR of 39.82%. Given TitMar’s stated hurdle rate of 18%, the project looks like a winner.
Even though the project looks like very good based on management’s estimates, it is risky and can turn from a positive-NPV investment to a negative one with relatively modest changes in the key value drivers. Develop a spreasheet model of the project valuation and answer the following questions
a. If the firm’s market share turns out to be only 5%, what happens to the project’s NPV and IRR?
b. If the market share remains at 15% and the price of the PTV falls to $4, 500, what is the resulting NPV?
Attached is the Exhibit P3-4.1
Please see attached document (2-6)
Forecasting and Valuing Cash Flows
2-6) CT Computers is considering whether or not to begin offering customers the option to have their old personal computers recycled when they purchase a recycling system. The recycling system would require that CT invest $600,000 to purchase grinder and magnets to use in the recycling process. The company estimates that for each system it recycles it would generate $1.50 in incremental revenues from the sale of scrap metal and plastics. The machinery has a five-year useful life and will be depreciated straight line toward a zero salvage value. CT believes that in Year 1 it will recycle 100,000 personal computers and that returns will grow by 25% each year over the next five years. The company uses a 15% discount rate to analyze its capital expenditures and faces a 30& tax rate.
a) What are the project free cash flows (PFCFs) for this project?
b) Using NPV and IRR, should CT invest in this project?
c) Judy Dunbar, the manager for the project, is worried that CT will only have returns of 75,000 units in Year 1. If she’s right, and assuming a growth rate of 25% should CT still consider investing in the project?
I need help with the following issues: how to calculate the net present value and the dollar value per year attach to the intangible benefits?
“I am not sure we should lay out $500,000 for that automated welding machine”, said JA president of SEC. “That’s a lot of money, and it would cost us $80,000 for software and installation, and another $3,000 every month just to maintain the thing. In addition, the manufacturer admits that it would cost $45,000 more at the end of the seven years to replace the worn-out parts.”
The machine would replace six welders at a cost savings of $108,000 per year and it would save another $6,500 per year in reduced material waste. The new automated welder will last for 12 years. The required rate of return for the company is 16%
The old welding equipment scrap value is $12,000 if is sold now, and in 12 years the new machine will only be worth $20,000 for parts.
1. Compute the net annual cost savings promised by the automated welding machine.
2. Using the data from (1) above and the other data from the problem, compute the automated welding machine’s net present value. Use the incremental-cost approach. Would you recommend purchasing the automated welding machine? Explain.
3. Assume that management can identify several intangible benefits associated with the automated welding machine, including greater flexibility in shifting from one type of product to another, improved quality of output, and faster delivery as a result of reduced throughput time. What dollar value per year would management have to attach to these intangible benefits in order to make the new welding machine an acceptable investment?
James LaGrande had recently been appointed Controller of the Breakfast Cereals Division of a major food company. One of Jim’s first assignments was to prepare the financial analysis for a new cold cereal, Krispie Krinkles.
Mr. LaGrande discussed the product with the food lab that had designed it, with the market research department that had tested it, and with the finance people who would have to fund its introduction. After putting together all the information, he developed the following optimistic and pessimistic sales projections:
Optimistic
Pessimistic
Year 1
$1,600,000
$800,000
Year 2
3,600,000
1,200,000
Year 3
5,000,000
1,000,000
Year 4
8,000,000
800,000
Year 5
10,000,000
400,000
The optimistic predictions assume a successful introduction of a popular product. The pessimistic predictions assume that the product is introduced but does not gain wide acceptance and is terminated after 5 years. LaGrande thinks the most likely results are halfway between the optimistic and pessimistic predictions.
LaGrande learned from finance that this type of product introduction requires a predicted rate of return of 16% before top management will authorize funds for its introduction. He also determined that the contribution margin should be about 50% on the product, but could be as low as 42% or as high as 58%. Initial investment would include $3 million for production facilities, $2.5 million for advertising and other product introduction expenses, and $500,000 for working capital (inventory, etc.). The production facilities would have a value of $800,000 after 5 years.
Prepare a capital-budgeting analysis to determine whether or not to launch the product.
The Johnson Company is evaluating the proposed acquisition of a new milling machine. The machine’s base price is $108,000, and it would cost another $12,500 to modify it for special use. The machine falls into the MACRS 3-year class, and would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of
$5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before tax operating costs, mainly labor. Johnson’s marginal tax rate is 35%.
What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)
What are the net operating cash flows in Years 1,2,and 3?
What is the additional (nonoperating)cash flow in Year 3?
If the project’s cost of capital is 12%, should the machine be purchased?
Show the equation so I can understand how to do it correctly. Thanks a lot for all of your help.
Borghia Pharmaceuticals has $1 million allocated for capital expenditures. Which of the following projects should the company accept to stay within the $1 million budget? How much does the budget limit cost the company in terms of its market value? The opportunity cost of capital for each project is 11 percent.
Please help with the following question and show all your work.
1. You have been asked by the President of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck’s basic price is $60,000. The truck falls into the four year class using straight line depreciation method, and it will be sold after four years for $0. The use of this new truck will bring revenue of $25,000 annually, and will have annual maintenance expense of $5,000. The firm’s marginal tax rate is 40 percent and the required rate of return is 10%.
1a. What is the initial investment?
1b. What is the Cash Flow at year 1?
1c. What is the Cash Flow at year 4?
—
2. Lotus Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The firm’s cost of capital is 12%. The after tax cash flows, including depreciation, for the truck and the pulley are as follows:
Year Truck Pulley
0 -50,000 -70,000
1 10,000 15,000
2 10,000 15,000
3 10,000 15,000
4 10,000 15,000
5 10,000 15,000
6 10,000 15,000
7 10,000 15,000
2a. What is the payback period for the truck?
2b. What is the payback period for the pulley?
2c. What is NPV for the truck?
2d. What is NPV for the pulley?
2e. What is IRR for the truck?
2f. What is IRR for the pulley?
I am currently taking an online class and I am trying to understand this problem that is deals with capital budgeting.
The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $150,000 with a disposal value of $40,000 and would be able to produce 5,000,000 cans over the life of the machinery. The production department estimates that approximately 1,000,000 cans would be needed for each of the next five years.
In addition to the purchase cost of the equipment, $12,000 would be needed to train three new employees in the production process. These three individuals would be full-time employees working 2,000 hours per year and earning $10.00 per hour. They would also receive the same benefits as other production employees, 18% of wages in addition to $2,200 of health benefits.
It is estimated that the raw materials will cost 30¢ per can and that other variable costs would be 4¢ per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.
It is expected that cans would cost 50¢ per can if purchased from the current supplier. The company’s minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint as well as number of units sold will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased.
What is the following:
Annual cash flows over the expected life of the equipment
Payback period
Scenario:
The meeting with the analyst went well. However, you want to crunch the numbers yourself to ensure accuracy. Furthermore, you need to consider the project in the broader context of how the new production facility can help the company increase output and, more importantly, profits. You know that the CFO will ask you to analyze the project at different hurdle rates, determine the implication on earnings and cash flow, and articulate why this project was chosen over the multitude of options that exists.
Task:
Create an Excel spreadsheet for a production plant that the company will lease for 5 years at US$1,500,000 per year; it will cost the firm US$4,000,000 in capital (straight-line depreciation, 5 year life) in year 0; it will cost the firm an additional US$150,000 per year after the new production plant is brought online for other expenses; and it will generate an incremental revenue of US$3,500,000 per year. Use a 40% tax rate, a 10% cost of capital, and a 12% re-investment rate. Assume the company will use cash flow to finance the project.
Discuss how the project would fair under hurdle rate scenarios of 10%, 15%, and 20% (based on MIRR). Based on results do we accept or reject at each hurdle rate? 10-15-20
Calculate NPV, MIRR
Need to discuss these questions in class.
Waste Industries is evaluating a $70,000 project with the following cash flows.
Year Cash Flows
1 $11,000
2 16,000
3 21,000
4 24,000
5 30,000
The coefficient of variation for the project is .847.
Based on the following table of risk-adjusted discount rates, should the project be undertaken? Select the appropriate discount rate and then compute the net present value.
Coefficient of Variation Discount Rate
0 – .25 6%
26 – .50 8
. 51 – .75 10
76 – 1.00 14
1.01 – 1.25 20
The warrants of Integra Life Sciences allow the holder to buy a share of stock at $11.75 and are selling for $2.85. The stock price is currently $8.50. What price must the stock go to for the warrant purchaser to at least be assured of breaking even?
The Redford Investment Company bought 100 Cinema Corp. warrants one year ago and would like to exercise them today. The warrants were purchased at $24 each, and they expire when trading ends today (assume there is no speculative premium left.) Cinema Corp. common stock is selling today for $50 per share. The exercise price is $30 and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.
a. If the warrants are exercised today, what would the Redford Investment Company’s dollar profit or loss be?
b. What is the Redford Investment Company’s percentage rate of return?
The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for $3 million. Kent has a $700,000 tax loss carry-forward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 30 percent. Kent will provide $420,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If the Clark Corporation has a cost of capital of 13 percent, should the merger be undertaken?
Can someone help with the following question?
The following is stream of expect cash flows from a project to replace an old sail boat with a new one. The new boat will cost $15,000 and will be good for 5 years. It will be traded-in for another boat at the end of its useful life. The following cash flows are expected:
Year 1 $5000
Year 2 $5000
Year 3 $4000
Year 4 $3000
Year 5 $8000
The RADR for this boat is $12%. Calculate the NPV, IRR (Using excel), payback period, discounted payback, PI and MIRR using the 12% at the reinvestment. The target payback is 5 years.
In reviewing a capital project the company is looking to undertake. The project is a new line of goods the company will produce. The CEO has stated that the decision to move forward will be driven by the net present value of the project (it must be positive), and the modified internal rate of return must be at least 13%. Here are the key facts about the project:
It is expected to produce US$3 million in revenue annually the first year and grow 5% per year thereafter.
The project will increase operating expenses by US$1.75 million the first year and grow at 3% annually per year thereafter.
The project cost US$6 million in capital, and the capital will be depreciated on a straight-line basis for 5 years.
The US$6 million will all be spent in the year prior to the first year in which the company generates revenue.
The company will evaluate the project over 5 years (not including year 0).
The company has a 40% tax rate.
For this project you will use a 12% cost of capital and a 13% reinvestment rate.
Given this information, find the NPV, MIRR, and which year the present value cash flows become positive.
Congratulations! Your work on understanding and managing the costs and profitability of Claire’s Antiques has resulted in record-breaking sales volume and profits. As a result, senior management is considering two new warehouse locations in order to serve its customers in the North and West more efficiently. Unfortunately, the company only has sufficient funds to invest into only one warehouse location at this time. Each warehouse will require that a new building be constructed. Claire’s Antiques expects to use the warehouse for five (5) years before building a new production facility in that area. Senior management hired a consulting firm to research the potential warehouse locations. You were at a meeting with the researchers and they gave you the results of the research.
Create a power point presentation that you will make to management. Use the following assumptions:
Assume the risk-adjusted cost of capital is 10% and its tax rate is 40%. Compute the net present value (NPV) for each warehouse proposal. Include the cash flows from salvage value and the tax benefits of depreciation (assume 5-year straight-line). Incorporate the research data and graphs and charts into your presentation for support to your recommendation.
Include in your presentation recommendations on the desired warehouse location for senior management. Specify how your recommendation is affected by your assumptions for cost of capital and expected contribution margin (that is, perform a sensitivity analysis)?
The PowerPoint should include notes and graphs. Complete the calculations for cash flow and discounting in Excel.
Objective: Use capital budgeting to evaluate investment proposals.
Which capital budgeting technique is consistent with maximizing shareholder wealth and why?
1.Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital is 12 percent. (Hint: Begin by constructing a time line)
a. what is the projects payback period (to the closest years)?
b. what is the projects discounted payback period?
c. what is the projects npv?
d. what is the projects irr?
e. what is the projects mirr?
2. Your division is considering two investment projects, each of which requires an up-front expenditure of $15 million. You estimate that the investments will produce the following net cash flows:
Year Project A Project B
1 $5,000,000 $20,000,000
2 10,000,000 10,000,000
3 20,000,000 6,000,000
What are the two projects net present values, assuming the cost of capital is 10 percent? 5 percent? 15 percent?
Graphic Systems purchased a computerized measuring device two years ago for $80,000.00. It falls into the five-year category for MACRS depreciation. The equipment can currently be sold for $28,400.00.
A new piece of equipment will cost $210,000.00. It falls into the five-year category for MACRS depreciation.
Assume the new equipment would provide the following stream of added cost savings for the next six years.
Year Cost Savings
1………… $76,000
2………… 66,000
3………… 62,000
4………… 60,000
5………… 56,000
6………… 42,000
The tax rate is 34 percent and the cost of capital is 12 percent.
a. What is the book value of the old equipment?
b. What is the tax loss on the sale of the old equipment?
c. What is the tax benefit from the sale?
d. What is the cash inflow from the sale of the old equipment?
e. What is the net cost of the new equipment?(include the inflow from the sale of the old equipment.)
f. Determine the depreciation schedule for the new equipment.
g. Determine the depreciation schedule for the remaining years of the old equipment.
h. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits.
The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business computer system. The initial investment will be $35,000. The computer is in the 5-year MACRS category, and the firm’s tax rate is 34%. The computer system is expected to provide additional revenue of $15,000 per year for the next six years, and to reduce expenses by $10,000 per year for the same period.
(a) Calculate the net after-tax cash flows from this investment.
(b) Calculate the net present value of the system, that the law firm’s weighted average cost of capital is 12%.
(c) Should they buy the computer system?
A steel comapny is the using the capital asset pricing model to evaluate a possible investment project.
The proposed project involves an investment of 15.2 million to start uo a toy manufacturing plant. the proposed project has about the same risk as the maerket(beta=1) and a project return of 30 percent. Additionally, the project has virtue of helping the company diversify away from total reliance on the steel business. The government bond rate is 12 percent and the market risk premium is 10 percent. For the steel campany as presently constituted, the beta is 2.2 Should the steel company undertake the proposed investment? explain your answer ( step of calcualtion must be shown)
Global Technology is considering investing in a new computer system. The system would be used for all of the firm’s business applications and is expected to yield the following (incremental) benefits (with all other yearly flows remaining constant):
* Additional sales revenue of $50,000 per year, given the fact that the system will be able to provide better sales support materials and optimally track customer-service information.
* Utility cost savings of $70,000 per year, as the temperature control/cooling requirements of this new system are much less than the requirements of the current system.
* Inventory cost savings of $60,000 per year, as the inventory software on the new system will help Global keep better track of inventory (levels) and allow Global to order inventory Just In Time basis.
* A reduction in Bad Debt Expense of $40,000 per year, as the Accounts Receivables package for this system will help Global do a better job of analyzing credit applicants, generating invoices in a timely fashion, and collecting outstanding balances (due).
The purchase price for this new system is $400,000. In addition, Global will have to pay for transportation/delivery costs will be $5,000 and installation/set-up costs will run about $25,000.
The useful life of the machine is estimated to be 3 years. At the end of the useful life, Global should be able to realize a (gross) salvage value of $30,000, although the firm incur costs of $10,000 to realize the salvage value. All yearly savings associated with the new system are assumed to last throughout the asset’s useful life, starting in year 1.
Global currently has the following capital structure:
Debt………40%
Preferred Stock……10%
Common Equity……50%
The cost of debt is 10 percent; the cost of preferred stock is 15 percent and the cost of equity is 20 percent.
Using the information provided, determine the Net Present Value of this proposed project. Should Global pursue this project? Why or Why not?
Verify Answer:
Revenue $50K
Utilities $70K
Inventory $60K
Bad Debt $40K
Total Inflows = $220K
Cost of new system = $400K
Transportation cost = $ 5k
Set-up cost = $25K
Total Outflows = $430K
Useful life of machine 3 years
Salvage value of maching = $30K
Salvage value incur cost = ($10K) ?????
Net Salvage Value = $20K
WACC = Debt 40% Cost of Debt = 10%
Preferred Stock 10% Cost of Pref. Stock = 15%
Common Stock 50% Cost of common stock = 20%
WACC = Wd Kd(1-t) + Wps Kps + Wcs Kcs
WACC = .40(10%) + .10 (15%) + .50 (20%)
WACC = 4.0% + 1.5% + 10%
WACC = 15.50% or discount rate
NPV = NCFo + NCF1/(1+r)^1 + NCF2/(1+r)^2 + NCF3/(1+r)^3 + Salvage Value/(1+r)^3
NPV = ($430,000)+$220,000/1.1550+$220,000/(1.1550)^2 + $220,000/(1.1550)^3
+ $20,000/(1.1550)^3
NPV = (430,000) + $190,476.19 + $164,914.45 + $142,783.07 + $12,980.28
NPV=$81,153.99 ; yes, pursue project since NPV>0, which yields a positive cash flow over 3 years.
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.
1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2. Calculate the Payback Period (P/B) and the NPV for the project.
3. Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
4. If the project required additional investment in land and building, how would this affect your decision? Explain.
1. Create an Incremental Cash Flow schedule for years one to eight.
2. Input year zero values for:
a. Initial investment
b. Net Working Capital
3. Compute and enter the Operating Cash Flows for years
a. 1
b. 2 to 5
c. 6 to 8
4. Get the total cash flow for each year
5. Compute the Net Present Value
6. Compute the Payback Period
7. Use the Capital Budgeting Techniques (NPV & Payback) to decide whether the project should be accepted or rejected.
5 questions: IRR,NPV, discount payback – file attached
Brutus can purchase equipment on sale for $4,300. The asset has a three year life and will produce a cash flow of $1200 in each of the first and second years, and $3000 in the third year. The interest rate is 12 percent.
Calculate the payback period.
Calculate the IRR. Should the project be taken?
Compute the project’s NPV.
Consider two mutually exclusive R&D projects that XYZ, a chip manufacturer, is considering. Assume the corporate discount rate is 15 percent and the minimum acceptable IRR is 25 percent.
Project A: Server CPU 0.13 micron processing project. By shrinking the die size to 0.13 micron, XYZ will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs.
Project B: New telecom chip project. Entry into this industry will require introduction of a new chip for cell phones. The know-how will require large upfront capital, but success of the project will lead to larger cash flows later on.
Year A B
0 -$100,000 -$200,000
1 50,000 60,000
2 50,000 60,000
3 40,000 60,000
4 30,000 100,000
5 20,000 200,000
SUM $ 90,000 $ 280,000
a. Calculate the NPV, IRR, incremental IRR, and PI for both projects.
b. Discuss the financial implications associated with these two projects.
Conch Republic Electronics
Conch Republic Electronics is a mid sized electronics manufacturer located in Key West, Florida. The company president is Shelley Couts, who inherited the company. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company’s finance department.
One of the major revenue-producing items manufactured by Conch Republic is a personal digital assistant (PDA). Conch Republic currently has one PDA model on the market, and sales have been excellent. The PDA is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Conch Republic developed a prototype for a new PDA that has all the features of the existing PDA but adds new features such as cell phone capability. The company has performed a marketing study to determine the expected sales figures for the new PDA.
Conch Republic can manufacture the new PDA for $200 each in variable costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimated sales volume is 70,000, 80,000, 100,000, 85,000, and 75,000 per each year for the next five years, respectively. The unit price of the new PDA will be $340. The necessary equipment can be purchased for $16.5 million and will be depreciated on a 5 year straight-line schedule.
Net working capital investment for the PDAs will be $6,000,000 the first year of operations. Of course NWC will be recovered at the projects end. Conch Republic has a 35 percent corporate tax rate and a 12 percent required return.
Shelly has asked Jay to prepare a report that answers the following questions:
1. What is the IRR of the project?
2. What is the NPV of the project, based on the required rate of return of 12%?
Please submit the excel solution spreadsheet on this assignment.
Harris Corporation provides the following data on a proposed capital project:
Initial investment $200,000
Expected useful life 4 years
Increase in annual net cash inflow (before taxes) $66,000
Required rate of return 12%
Income tax rate 25%
Harris uses straight-line depreciation method with no salvage value.
Required: compute for this project:
a. NPV.
b. IRR (to the nearest tenth of a percent)
c. Payback period.
d. Book rate of return on the net initial investment.
**Use Excel Spreadsheet**
See attached file.
UNIT 3 PROFESSIONAL CHALLENGE- INSTRUCTIONS
Please follow the instructions below to complete the assignment. I have attached a Unit 3 Professional Challenge- Blank Answer Template. Please use it to fill in your answers. The cells that need to be filled in are in the color gray. Virtually all of the cells should have formulas (or linked to other cells) in order to show your work and logic. You must use formulas for your calculations rather than just pasting in numbers. Feel free to use a financial calculator to verify your answers but you want to use the Excel formulas. Points will be deducted without showing how your calculations are derived. Also, notice that your NPV & IRR answers should be in the gray cells to the right of where it says NPV & IRR. The memo should be approximately two pages.
1. For the WACC, use 7.50%. I fixed the WACC rate for everyone so you will not have to attempt to calculate it from your chosen company. This will save you time. So you will not need to calculate the WACC, only explain it in your paper. You will be calculating 1) Depreciation, 2) Tax Rate, 3) Taxable Income, 4) NOPAT, 5) Net Cash Flow, and the two major calculations- NPV & IRR.
2. You need to find the Net Cash Flows for years 0 thru 5 for Machine A and B. Then find the NPV and IRR of these cash flows. Year 0 thru Year 5 will be the time line for your cash flows.
3. Plug in the given EBITD numbers for the 5 years for each Machine.
4. For Depreciation, use 33% for year 1, 45% for year 2, 15% for year 3, 7% for year 4, and 0% for year 5. You will multiply these percentages by 120,000 for Machine A and 60,000 for Machine B. (Note: Make sure the $120,000 and $60,000 are POSITIVE numbers when you multiply the depreciation percentages by them.
5. Taxes for each year will equal (Taxable Income times 40%.)
6. Taxable Income will equal (EBITD minus Depreciation) for each year.
7. Net Operating Profit After Taxes (NOPAT) equals (Taxable Income minus %).
8. To find the Net Cash Flow, negative -$120,000 will be the year 0 Net Cash Flow for Machine A and negative -$60,000 will be the year 0 Net Cash Flow for Machine B. (Note: Ignore Salvage Value for Machine A).
9. Net Cash Flow equals (NOPAT + Depreciation). Remember that depreciation is a noncash expense so you add it back to NOPAT.
10. Once you have calculated the Net Cash Flows for Year 0 thru Year 5 for each Machine then you are ready to find the NPV and IRR. Remember, For year 0 for Machine A, you will use the initial cash outlay of -120,000 and -60,000 for Machine B. For the NPV calculation, use the 7.50% WACC as the discount rate.
11. Be sure to use the NPV & IRR formulas in Excel. For the NPV calculations, you want to assume that the cash flows occur at the BEGINNING of each period. So be sure to keep the year 0 cash flow outside and added to the parenthesis of the formula. The Excel Examples spreadsheet that I posted under the Faculty Expectations thread has an example of it.
12. In your Word document, be sure to discuss the following topics. It needs to be approximately two pages in length:
A) After calculating the NPV and IRR for Machine A and Machine B, choose which one you would choose based on being the most profitable.
B) Would an investor choose an investment with the highest NPV or IRR? Justify which one and why.
C) Discuss capital rationing limits firms have and what, if anything they can do,
D) Discuss the MIRR and its advantages/disadvantages.
E) Discuss the WACC.
Create an Excel spreadsheet for a production plant with the following criteria:
– The company will lease for 5 years at $1,500,000 per year.
– It will cost the firm $4,000,000 in capital (straight-line depreciation, 5 year life) in year 0.
– It will cost the firm an additional $150,000 per year after the new production plant is brought online for other expenses.
– It will generate incremental revenue of $3,500,000 per year.
Use a 40% tax rate, a 10% cost of capital, and a 12% reinvestment rate. Assume the company will use cash flow to finance the project.
In a separate document, indicate how the project would fair under hurdle rate scenarios of 10%, 15%, and 20% (based on MIRR).
I’m having problems with this problem. I’m getting the same response for both process A and B.
Eagle Feather Company is considering investing in a new process which would improve manufacturing efficiency in the production of its principal product. The company can either invest in Process A for $150,000 which is easy to install and immediately begins to return cash back to the company, or Process B for $250,000 which is much more difficult to install but has the potential of returning greater cash flows in improved efficiencies. The after tax cash flows of the new processes are as follows:
Process A Process B
Initial Investment -$150,000 -$250,000
Year 1 $ 45,000 $ 25,000
Year 2 $ 55,000 $ 45,000
Year 3 $ 65,000 $125,000
Year 4 $ 75,000 $150,000
Year 5 $ 85,000 $175,000
a. If the company’s Cost of Capital is 13%, what is the Payback, Net Present Value, and Profitability Index for each of these projects?
b. The Controller has calculated that the Internal Rate of Return on Project A is 29% and on Project B is 22%. She wants to undertake Project A. What do you recommend based on your analysis?
Integrative Problem
It’s been two months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. The memorandum you received outlining your assignment follows:
TO: The Assistant Financial Analyst
FROM: Mr. V. Morrison, CEO, Caledonia Products
RE: Cash Flow Analysis and Capital Rationing
12. Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows:
YEAR PROJECT A PROJECT B
0 -$100,000 -$100,000
1 32,000 0
2 32,000 0
3 32,000 0
4 32,000 0
5 32,000 $200,000
The required rate of return on these projects is 11 percent. (Keown, Martin, Petty, & Scott, 2005, chapter 10 p. 1)
What is each project’s payback period?
What is each project’s net present value?
What is each project’s internal rate of return?
What has caused the ranking conflict?
Which project should be accepted? Why?
11. Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows:
YEAR PROJECT A PROJECT B
0 $100,000 $100,000
1 32,000 0
2 32,000 0
3 32,000 0
4 32,000 0
5 32,000 $200,000
The required rate of return on these projects is 11 percent.
a. What is each project’s payback period?
Project A
Project B
b. What is each project’s net present value?
Project A
Project B
c. What is each project’s internal rate of return?
Project A
Project B
d. What has caused the ranking conflict?
Project A
Project B
e. Which project should be accepted? Why?
Project A
Project B
5.) Foxglove Corp. is faced with an investment project. The following information is associated with this project:
(see chart in attached file)
The project involves an initial investment of $100,000 in equipment that falls in the 3-year MACRS class and has an estimated salvage value of $15,000. In addition, the company expects an initial increase in net operating working capital of $5,000 which will be recovered in year 4. The cost of capital for the project is 12%. What is the project’s net present value? (Round the final answer to the nearest whole dollar.)
ZeeBancorp is considering the establishment of a contract collection service subsidiary that would provide collection service to small and midium size firms.
Compensation would be in the form of a percentage of the amount collected. For amounts collected up to $100, the fee is 55 percent of the amount collected. For amounts collected between $100 and $500, the fee would be 40 percent of the total amount collected on the account.
For amounts collected over $500, ZeeBancorp would receive 35 percent of the total amount collected on the account.
ZeBancorp expects to generate the following amount of business during the first year of operation of the subsidiary – see attachment.
Over the project 10-year life of this collection venture, the number of accounts in each group is expected to grow at 6% per annum.
The average amount collected from each account is expected to remain constant. To establish the collection subsidiary, ZeeBancorp will have to rent office space at a cost of $250,000 for the first year,(assume the rent is payable at the end of each year).
This amount is expected to grow at a rate of 11% per year. Other operating expenses (including depreciation) are expected to total $350,000 during the first year and grow at an 11% annual rate. ZeeBancorp will have to invest $150,000 in net working capital if it undertakes this venture. In addition, required new equipment will cost $275,000 to purchase and an additional $25,000 to install. This equipment will be depreciated using the MACRS schedule for a 7-year asset.
The salvage value for the equipment is estimated to be $50,000 at the end of 10 years. The firm`s marginal tax rate is estimated to be 40% over project`s life, and its average tax rate is projected to be 35 percent over the project`s life. The firm requires a 15 percent rate of return on projects ov average risks.
1. Compute the net investment required to establish the collection subsidiary.
2. Compute the annual cash flow over the 10-year life of project.
3. Compute the net present value of this project assuming it is an average-risk investment.
4. Should ZeeBancorp invest in the new subsidiary.
5. ZeeBancorp requires all expasion projects such as this to have a payback of four years or less. Under this conditions, should ZeeBancorp invest in the new subsidiary.
6. If management decides that this project has above-average risk and hence the required return is 20 percent, should the investment be made.
7. If collections are only 80 percent of projections and the required return is 20 percent, should the investment be made.
8. If operating (excluding depreciation) and lease expenses are expected to increase at an annual rate of 13 percent, should the collection subsidiary be established, assuming a required return of 20 percent and the original revenue projections?
The Seattle Corporation has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 8 percent.
a. What is the Payback Period, Discounted Payback Period, NPV, IRR, and MIRR for this investment?
b. Should the project be accepted or rejected?
Outline: Primitive Energy owns a coal seam gas reserve in south-west Queensland. Management is currently examining the economic viability of two gas extraction processes from which it can choose.
Task is to prepare a report that advises management of Primitive Energy on the optimal extraction process. This report must include a summary of each extraction option, a detailed discounted cash flow (DCF) analysis of each option and advice on which is the preferred option based on the DCF results.
All necessary information required for the analysis is provided in the Gas Extraction Summary Spreadsheet that has been compiled with the assistance of the company’s engineers and accountants.
See attachment for spreadsheet file
Most firms generate cash inflows everyday, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, our results are biased, and if so, would the NPV be biased up or down? Please show calculations as necessary.
Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regiona company. Sam is considering opening several new restaurants. Sally Thorton, the company’s CFO, has been put in charge of the capital budgeting analysis. She has examined the potential for the company’s expansion and determined that the success of the new restaurants will depend critically on the state of the economy next year and over the next few years.
McKenzie currently has a bond issue outstanding with a face value of $25 million that is due in one year. Convenants associated with this bond issue prohibit the issuance of any additinal debt. This restriction means that the expansion will be entirely financed with equity, at a cost of $9 million. Sally has summarized her analysis in the following table, which shows the value of the company in each state of the economy next year, both with and without expansion.
Economic Growth Probability Without expansion With expansion
Low .30 $20,000,000 $24,000,000
Normal .50 $34,000,000 $45,000,000
High .20 $41,000,000 $53,000,000
1. What is the expected value of the company in one year, with and without expansion? Would the company’s stockholders be better off with or without expansion? Why?
2. What is the expected value of the company’s debt in one year, with and without the expansion?
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.
1. Prepare a statement showing the incremental cash flows for this project over an 8-year period.
2. Calculate the Payback Period (P/B) and the NPV for the project.
3. Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
4. If the project required additional investment in land and building, how would this affect your decision? Explain.
A resource on financial functions in Excel is available in the Labs area. Click “Labs,” then “Student Success Learning Lab.” Click “Presentation Material” in the left navigation bar. Choose “Financial Functions” to download the file. When asked, be sure to click “Save,” rather than “Open.”
Select a U.S. government agency (local/state/federal) and discuss the following:
a. Discuss how the debt capacity of the governmental entity is determined.
b. Evaluate the effect of refunding or reorganizing existing debt obligations.
c. Analyze various funding alternatives that can be used to support debt obligation.
Superior Manufacturing is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building and land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%. Based on this information you are to complete the following tasks.
Prepare a statement showing the incremental cash flows for this project over an 8-year period.
Calculate the Payback Period (P/B) and the NPV for the project.
Based on your answer for question 2, do you think the project should be accepted? Why? Assume Superior has a P/B (payback) policy of not accepting projects with life of over three years.
If the project required additional investment in land and building, how would this affect your decision? Explain.
I would appreciate some assistance with the attached file.
Benford, Inc. is planning to open a new sporting goods store in a suburban mall. Benford will lease the needed space in the mall. Equipment and fixtures for the store will cost $200,000 and be depreciated over a 5-year period on a straight-line basis to $0. The new store will require Benford to increase its net working capital by $200,000 at time 0; thereafter, net working capital balances are expected to equal 20 percent of the following year’s sales. First-year sales are expected to be $1 million and to increase at an annual rate of 8 percent over the expected 10-year life of the store. Operating expenses (including lease payments and excluding depreciation) are projected to equal 70 percent of sales. The salvage value of the store’s equipment and fixtures is anticipated to be $10,000 at the end of 10 years. Benford’s marginal tax rate is 40 percent.
a. Calculate the store’s net present value, using an 18 percent required return.
b. Should Benford accept the project?
c. Calculate the store’s internal rate of return
d. Calculate the store’s profitability index.
Please see attached file.
1) What is the net investment required at t = 0?
2) What is the operating cash flow in Year 1?
3) What is the operating cash flow in Year 2?
4) What is the operating cash flow in Year 3?
5) What is the project’s NPV?
6) After seeing your analysis, the president has asked to recalculate the NPV if the sales volume is only 80,000 units per year instead of 100,000. This is an example of (or a component of)
A) Breakeven analysis
B) Sensitivity analysis
C) Scenario analysis
7) After you reevaluated the project based on the lower sales volume, the president asked you to reevaluate the project again, this time considering a lower and higher sales price, a higher and lower variable cost, a higher and lower fixed cost, and a lower and higher salvage value, showing the difference in NPV for the change in each variable. This exercise is an example of:
A) Breakeven analysis
B) Sensitivity analysis
C) Scenario analysis
8) The boss then asks you to recalculate NPV based on the worst case sales volume, worst case variable cost, and worst case sales price representing an overall downturn in market demand combined with inflationary input markets. In response to this request, you will perform:
A) Breakeven analysis
B) Sensitivity analysis
C) Scenario analysis
9) Finally, your boss asks you to calculate, based on the expected values for the sales price and fixed and variable costs, the sales volume required for the net income from the project to cover the cost of the investment. She has requested that you perform
A) Breakeven analysis
B) Sensitivity analysis
C) Scenario analysis
D) An unnecessary exercise that will be completely ignored by the capital budgeting committee
10) What is the final cash flow in year 4?
1. Which of the following is NOT a relevant factor when determining incremental cash flows for a new product?
a. The use of high quality factory floor space that is currently unused and therefore could be used to produce the proposed new product.
b. Revenues from an existing product that would be lost as a result of customers switching to the new product.
c. Shipping and installation costs associated with preparing a machine which would be used to produce the new product.
d. The cost of a marketing study that was completed last year related to the new product. This research led to the tentative decision to go ahead with the new product, and the cost of the research was expensed for tax purposes last year.
e. The land which would be used for the new project could be sold to another firm.
2. You work for Athens Inc., and you must estimate the Year 1 operating cash flow for a project with the following data. What is the Year 1 operating cash flow?
Sales revenues: $15,000
Depreciation: $4,000
Other operating costs: $6,000
Tax rate: 35.0%
a. $5,000
b. $7,250
c. $7,617
d. $7,807
e. $8,003
1. Which of the following statements is CORRECT?
a. Because depreciation is not a cash expense, it plays no role in capital budgeting.
b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
c. Under MACRS depreciation, firms write off assets slower than they would under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
d. Under MACRS depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
e. Under MACRS depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.
2. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear–there is no mortgage on it. Which of the following statements is CORRECT?
a. Because the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project.
b. If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.
c. This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.
d. Because the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.
e. If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
Capital Budgeting Question Attached.
1. Vextron Inc in Canada is planning on manufacture engine blocks for new vehicles. They expect to sell 250 blocks annually for the next 5 years. The foundry and machining equipment will cost a total of $800,000 and belongs in a 30% CCA (Capital Cost Allowance) class for tax purposes. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labour and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.
a. What is the depreciation tax shield in the third year for this project?
b. What is the present value of the CCA tax shield?
c. What is the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation?
d.. Assume that management believes that auto restorers will pay $3,000 retail per engine block. What is the NPV of this project?
Superior Manufacturers is considering a 3-year project with an initial cost of $846,000. The project will not directly produce any sales but will reduce operating costs by $295,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $30,000. The tax rate is 34 percent. The project will require $31,000 in extra inventory for spare parts and accessories. Should this project be implemented if Superior Manufacturing requires an 8 percent rate of return? Why or why not?
Senior management is considering two proposals to expand the product line. Expansion of the product line requires a new facility and production team. Senior management hired a consulting firm to research the potential product lines. Lava Rocks would like to make this product line for at least 5 years (so the evaluation is for 5 years of revenues and costs). You were at a meeting with the researchers and they gave you the results of the research. Download the file ACC350_p3IPs.pdf for the results of their research. Create a presentation that you will make to management. Use the following assumptions:
Assume the risk-adjusted cost of capital is 12%, compute net present value (NPV) for each proposal. Include the cash flows from salvage value and the tax benefits of depreciation (assume 5-year straight-line). Incorporate the research data and graphs and charts into your presentation for support to your recommendation.
Include in your presentation recommendations on the product line for senior management? Specify how your recommendation is affected by your assumptions for cost of capital and expected contribution margin (that is, perform a sensitivity analysis)?
Use capital budgeting to evaluate investment proposals
Borden Books is interested in purchasing a computer system to use for the next 10 years. Currently, Borden is considering two mutually exclusive systems, System S and System L.
System S has an up-front cost of $3 million at t = 0 and will produce positive cash flows of $2.5 million per year for two years (at t = 1 and 2). This system can be repeated forever. In other words, every two years the company can repurchase the system under exactly the same terms.
System L has an up-front cost of $5 million at t = 0 and will produce positive cash flows of $2 million per year for five years (at t = 1, 2, 3, 4, and 5). This system can be replaced at a cost of $4 million at t = 5, after which time it will produce positive cash flows of $1.5 million per year for the subsequent five years (at t = 6, 7, 8, 9, and 10).
Borden’s CFO has determined that the company’s WACC is 12 percent. Over a 10-year extended basis, which system is the better system and what is its NPV?
A.System L; $2.21 million
B.System L; $3.01 million
C.System S; $4.10 million
D.System L; $4.41 million
E.System S; $6.13 million
Johnson Jets is considering two mutually exclusive machines. Machine A has an up-front cost of $100,000 (CF0 = -100,000) and produces positive after-tax cash inflows of $40,000 a year at the end of each of the next six years.
Machine B has an up-front cost of $50,000(CF0 = -50,000) and produces after-tax cash inflows of $30,000 a year at the end of the next three years. After three years, Machine B can be replaced at a cost of $55,000 (paid at t = 3). The replacement machine will produce after-tax cash inflows of $32,000 a year for three years (inflows received at t = 4, 5, and 6).
The company’s cost of capital is 10.5 percent. What is the net present value (on a 6-year extended basis) of the most profitable machine?
A.$23,950
B.$41,656
C.$56,238
D.$62,456
E. $71,687
Holmes Corporation recently purchased a new delivery truck. The new truck costs $25,000 and is expected to generate net after-tax operating cash flows, including depreciation, of $7,000 at the end of each year. The truck has a 5-year expected life. The expected abandonment values (salvage values after tax adjustments) at different points in time are given below. (Note that these abandonment value estimates assume that the truck is sold after receiving the project’s cash flow for the year.) The firm’s cost of capital is 10 percent.
Year Abandonment value
1 $20,000
2 15,000
3 10,000
4 5,000
5 0
At what point in time would the company choose to sell (abandon) the truck in order to maximize its NPV?
A.After one year
B.After two years
C.After three years
D.After four years
E.It would never choose to sell the truck.
# 1. Stephenson & Sons has a capital structure that consists of 20 percent equity and 80 percent debt. The company expects to report $3 million in net income this year, and 60 percent of the net income will be paid out as dividends. How large must the firm’s capital budget be this year without it having to issue any new common stock?
The answer is 6.00 Million. My caculations were off. Can you please explain how to get the answer step by step.
# 2. Dandy Product’s overall weighted average required rate of return is 10 percent. Its yogurt division is riskier than average, its fresh produce division has average risk, and its institutional foods division has below-average risk. Dandy adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk?adjusted required rate of return for a low-risk project in the yogurt division?
The answer is 10%. My calculations didnt match this. Can you please explain how to get the answer step by step.
# 3. Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects have the same risk. Which of the following statements is most correct?
The answer is “If the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A”. I didnt even understand why this was the case. Can you please Explain.
THANK YOU VERY MUCH!
The Chang company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However the machine is good and will last another 10 years. The replacement machine will produce after-tax cash flows (labor savings and depreciation) of $9000 per year. The new machine will cost $40,000 and will last 10 years. It has a zero salvage value. The firm’s WACC is 10% and its marginal tax rate is 35 %. Should Chang buy the new machine?
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