BUSI 320 Homework 6 Capital Budgeting Assignment solutions complete answers

BUSI 320 Homework 6 Capital Budgeting Assignment solutions complete answers

 

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,677,000 and will produce $385,000 per year in years 5 through 15 and $529,000 per year in years 16 through 25. The U.S. gold mine will cost $2,036,000 and will produce $299,000 per year for the next 25 years. The cost of capital is 7 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods. (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Australian mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
  
a-1. Calculate the net present value for each project. (Do not round intermediate calculations and round your answers to 2 decimal places.)
  a-2. Which investment should be made?
    
b-1. Assume the Australian mine justifies an extra 5 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
  

 
  
b-2. Does the new assumption change the investment decision?

 

Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $26,600. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby’s cost of capital is 11 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods.
  

Cash Flow
 
Probability
 
$
4,370
 
 
 
0.3
 
 
 
5,640
 
 
 
0.2
 
 
 
8,190
 
 
 
0.2
 
 
 
10,300
 
 
 
0.3
 
 
 
  
a. What is the expected value of the cash flow? The value you compute will apply to each of the five years.



b. What is the expected net present value? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)



c. Should Debby buy the new equipment?

 

Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 11 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 16 percent. Either method will require an initial capital outlay of $93,000. The inflows from projected business over the next five years are shown next.  
  

Years
Method 1
Method 2
1
$
35,700
 
$
23,200
 
2
 
45,900
 
 
24,100
 
3
 
50,500
 
 
37,800
 
4
 
42,500
 
 
37,700
 
5
 
21,900
 
 
77,500
 
 
   
Use Appendix B for an approximate answer but calculate your final answers using the formula and financial calculator methods.

a. Calculate net present value for Method 1 and Method 2. (Do not round intermediate calculations and round your answers to 2 decimal places.)



b. Which method should be selected using net present value analysis?

 

Waste Industries is evaluating a $57,100 project with the following cash flows. 
 

Years
 
Cash Flows
1
 
$
9,210
 
2
 
 
21,400
 
3
 
 
18,500
 
4
 
 
25,600
 
5
 
 
24,300
 
 

The coefficient of variation for the project is 1.223.
 

Coefficient of Variation
 
Discount Rate
0
−
0.25
 
 
5
%
0.26
−
0.50
 
 
10
%
0.51
−
0.75
 
 
12
%
0.76
−
1.00
 
 
19
%
1.01
−
1.25
 
 
20
%
 
 
 
 

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Select the appropriate discount rate.

b. Compute the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)



c. Based on the net present value should the project be undertaken?

 

Mountain Ski Corp. was set up to take large risks and is willing to take the greatest risk possible. Lakeway Train Co. is more typical of the average corporation and is risk-averse.
 

Projects
Returns:
Expected Value
Standard
Deviation
A
$
298,000
 
$
210,000
 
B
 
704,000
 
 
454,000
 
C
 
164,000
 
 
133,000
 
D
 
196,000
 
 
252,000
 
 

a-1. Compute the coefficients of variation. (Round your answers to 3 decimal places.)



a-2. Which of the following four projects should Mountain Ski Corp. choose?

b. Which one of the four projects should Lakeway Train Co. choose based on the same criteria of using the coefficient of variation?

 

Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.
 

Investments
Returns:
Expected Value
Standard
Deviation
Buy stocks
$
9,470
 
$
6,120
 
Buy bonds
 
7,560
 
 
2,850
 
Buy commodity futures
 
20,400
 
 
26,100
 
Buy options
 
18,800
 
 
16,600
 
 

a-1. Compute the coefficients of variation. (Round your answers to 3 decimal places.)

 
a-2. Which one of the following four investments should Tim choose?

b. Which one of the four investments should Mike choose?

 

Five investment alternatives have the following returns and standard deviations of returns.
 

Alternatives
Returns:
Expected Value
Standard
Deviation
A
$
1,400
 
$
820
 
B
 
890
 
 
1,520
 
C
 
13,900
 
 
5,500
 
D
 
1,380
 
 
680
 
E
 
65,300
 
 
16,500
 
 

Calculate the coefficient of variation and rank the five alternatives from the lowest risk to the highest risk by using the coefficient of variation. (Round your answers to 3 decimal places.)

 

Shack Homebuilders Limited is evaluating a new promotional campaign that could increase home sales. Possible outcomes and probabilities of the outcomes are shown next.     
 

Possible Outcomes
Additional
Sales in Units
Probabilities
Ineffective campaign
 
60
 
 
0.30
 
Normal response
 
80
 
 
0.50
 
Extremely effective
 
160
 
 
0.20
 
 

Compute the coefficient of variation. (Do not round intermediate calculations. Round your answer to 3 decimal places.)

 

Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:
 

Possible Market Reaction
Sales in Units
Probabilities
Low response
 
35
 
 
0.20
 
Moderate response
 
45
 
 
0.20
 
High response
 
60
 
 
0.30
 
Very high response
 
70
 
 
0.30
 
 

a. What is the expected value of unit sales for the new product? (Do not round intermediate calculations and round your answer to the nearest whole unit.)



b. What is the standard deviation of unit sales? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

Assume you are risk-averse and have the following three choices.
 

 
Expected
Value
 
Standard
Deviation
 
A
$
1,940
 
 
$
1,280
 
 
B
 
2,770
 
 
 
1,540
 
 
C
 
1,950
 
 
 
1,320
 
 
 

a. Compute the coefficient of variation for each. (Round your answers to 3 decimal places.)



b. Which project will you select?

 

Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $84,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $37,800. A new piece of equipment will cost $205,000. It also 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. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

Year
 
Cash Savings
1
 
$
64,000
 
2
 
 
54,000
 
3
 
 
52,000
 
4
 
 
50,000
 
5
 
 
47,000
 
6
 
 
36,000
 
 

The firm’s tax rate is 25 percent and the cost of capital is 10 percent.


a. What is the book value of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



b. What is the tax loss on the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



c. What is the tax benefit from the sale? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



d. What is the cash inflow from the sale of the old equipment? (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



f. Determine the depreciation schedule for the new equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)



g. Determine the depreciation schedule for the remaining years of the old equipment. (Round the depreciation base and annual depreciation answers to the nearest whole dollar. Round the percentage depreciation factors to 3 decimal places.)



h. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits. (Enter the tax rate as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)



i. Compute the aftertax benefits of the cost savings. (Enter the aftertax factor as a decimal rounded to 2 decimal places. Round all other answers to the nearest whole dollar.)



j-1. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual benefits. (Do not round intermediate calculations and round your answers to the nearest whole dollar.)



j-2. Compute the present value of the total annual benefits. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)



k-1. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e). (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to the nearest whole dollar.)



k-2. Should the replacement be undertaken?

 

DataPoint Engineering is considering the purchase of a new piece of equipment for $220,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $120,000 in nondepreciable working capital. $30,000 of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12–11, Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

Year
Amount
1
$
179,000
 
 
 
2
 
156,000
 
 
 
3
 
126,000
 
 
 
4
 
111,000
 
 
 
5
 
93,000
 
 
 
6
 
83,000
 
 
 
 
 
 

The tax rate is 25 percent. The cost of capital must be computed based on the following:

 

 
 
Cost
(aftertax)
Weights
Debt
Kd
 
7.50
%
 
30
%
 
 
Preferred stock
Kp
 
11.20
 
 
10
 
 
 
Common equity (retained earnings)
Ke
 
16.00
 
 
60
 
 
 
 
 
 

a. Determine the annual depreciation schedule. (Do not round intermediate calculations. Round your depreciation base and annual depreciation answers to the nearest whole dollar. Round your percentage depreciation answers to 3 decimal places.)



b. Determine the annual cash flow for each year. Be sure to include the recovered working capital in Year 6. (Do not round intermediate calculations and round your answers to 2 decimal places.)



c. Determine the weighted average cost of capital. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)



d-1. Determine the net present value. (Use the WACC from part c rounded to 2 decimal places as a percent as the cost of capital (e.g., 12.34%). Do not round any other intermediate calculations. Round your answer to 2 decimal places.)



d-2. Should DataPoint purchase the new equipment?

 

An asset was purchased three years ago for $180,000. It falls into the five-year category for MACRS depreciation. The firm is in a 25 percent tax bracket. Use Table 12–12.


a. Compute the tax loss on the sale and the related tax benefit if the asset is sold now for $21,060. (Input all amounts as positive values. Do not round intermediate calculations and round your answers to whole dollars.)


 b. Compute the gain and related tax on the sale if the asset is sold now for $68,060. (Input all amounts as positive values. Do not round intermediate calculations and round your answers to whole dollars.)

 

The Summit Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $140,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-12.

 

 
 
 
 
Year 1
$
80,000
 
Year 2
 
92,000
 
Year 3
 
44,000
 
Year 4
 
42,000
 
 

The firm is in a 35 percent tax bracket and has a cost of capital of 7 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.


a. Calculate the net present value. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)



b. Under the net present value method, should Summit Petroleum Corporation purchase the asset?

 

Telstar Communications is going to purchase an asset for $520,000 that will produce $250,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three-year MACRS depreciation schedule in Table 12–12. (This represents four years of depreciation based on the half-year convention.) The firm is in a 25 percent tax bracket.


Fill in the schedule below for the next four years.

 

Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows: Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
 

Project E
 
Project H
($54,000 Investment)
 
($48,000 Investment)
Year
Cash Flow
 
Year
Cash Flow
1
$
12,000
 
 
1
$
24,000
 
2
 
16,000
 
 
2
 
17,000
 
3
 
26,000
 
 
3
 
18,000
 
4
 
33,000
 
 
 
 
 
 
 

a. Determine the net present value of the projects based on a zero percent discount rate.



b. Determine the net present value of the projects based on a discount rate of 11 percent. (Do not round intermediate calculations and round your answers to 2 decimal places.)



c. If the projects are not mutually exclusive, which project(s) would you accept if the discount rate is 11 percent?

 

Turner Video will invest $50,500 in a project. The firm’s cost of capital is 10 percent. The investment will provide the following inflows. Use Appendix A for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

Year
Inflow
1
$
11,000
 
2
 
13,000
 
3
 
17,000
 
4
 
21,000
 
5
 
25,000
 
 

The internal rate of return is 13 percent.


a. If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years? (Assume the inflows come at the end of each year.) (Do not round intermediate calculations and round your answer to 2 decimal places.)
 

  


b. If the reinvestment assumption of the internal rate of return method is used, what will be the total value of the inflows after five years? (Use the given internal rate of return. Do not round intermediate calculations and round your answer to 2 decimal places.)

 

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 13 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

Project X (Videotapes
of the Weather Report)
($52,000 Investment)
 
Project Y (Slow-Motion
Replays of Commercials)
($72,000 Investment)
Year
Cash Flow
 
Year
Cash Flow
1
$
26,000
 
 
1
$
36,000
 
2
 
24,000
 
 
2
 
29,000
 
3
 
25,000
 
 
3
 
30,000
 
4
 
24,600
 
 
4
 
32,000
 
 
  
a. Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal places.)



b. Calculate the profitability index for project Y. (Do not round intermediate calculations and round your answer to 2 decimal places.)



c. Which project would you select based on the profitability index?

 

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $72,000. The annual cash flows have the following projections. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

Year
Cash Flow
1
$
35,000
 
2
 
38,000
 
3
 
35,000
 
4
 
28,000
 
5
 
12,000
 
 

a. If the cost of capital is 12 percent, what is the net present value of selecting a new machine? (Do not round intermediate calculations and round your final answer to 2 decimal places.)
 


b. What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)



c. Should the project be accepted?

 

Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $34,000. The annual cash inflows for the next three years will be:
 

Year
Cash Flow
1
 
$
17,000
 
2
 
 
15,000
 
3
 
 
10,000
 
 

Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the financial calculator method.


a. Determine the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)



b. With a cost of capital of 14 percent, should the equipment be purchased?

 

You buy a new piece of equipment for $26,621, and you receive a cash inflow of $3,500 per year for 15 years. Use Appendix D for an approximate answer but calculate your final answer using the financial calculator method.


What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

 

X-treme Vitamin Company is considering two investments, both of which cost $36,000. The cash flows are as follows:

 

Year
Project A
Project B
1
$
38,000
 
$
36,000
 
2
 
10,000
 
 
8,000
 
3
 
12,000
 
 
18,000
 
 
 

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
 

a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.)



a-2. Which of the two projects should be chosen based on the payback method?
  

multiple choice 1

 Project A
 Project B
 

b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.)



b-2. Which of the two projects should be chosen based on the net present value method?
  

multiple choice 2

 Project B
 Project A

c. Should a firm normally have more confidence in the payback method or the net present value method?

 

The Short-Line Railroad is considering a $130,000 investment in either of two companies. The cash flows are as follows:
 

Year
Electric Co.
Water Works
1
$
90,000
 
$
20,000
 
2
 
20,000
 
 
20,000
 
3
 
20,000
 
 
90,000
 
4 – 10
 
25,000
 
 
25,000
 
 

a. Compute the payback period for both companies. (Round your answers to 1 decimal place.)



b. Which of the investments is superior from the information provided?

 

Assume a corporation has earnings before depreciation and taxes of $117,000, depreciation of $45,000, and that it has a 35 percent tax bracket.
 

a. Compute its cash flow using the following format. (Input all answers as positive values.)



b. How much would cash flow be if there were only $11,000 in depreciation? All other factors are the same.



c. How much cash flow is lost due to the reduced depreciation from $45,000 to $11,000?