BUSI 320 Quiz 3 Valuation, Cost of Capital and Capital Budgeting solutions complete answers

BUSI 320 Quiz 3 Valuation, Cost of Capital and Capital Budgeting solutions complete answers

 

King’s Department Store is contemplating the purchase of a new machine at a cost of $18,392. The machine will provide $4,100 per year in cash flow for six years. King’s has a cost of capital of 13 percent. Use Appendix D for an approximate answer but calculate your final answer using the financial calculator method.


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



b. Should the project be undertaken?

 

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 $15,800. 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 13 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods.

 

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 12 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 17 percent. Either method will require an initial capital outlay of $110,000. The inflows from projected business over the next five years are shown next.  

 

Waste Industries is evaluating a $55,500 project with the following cash flows. 

 

Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $90,000. The annual cash inflows for the next three years will be:

 

Turner Video will invest $66,500 in a project. The firm’s cost of capital is 12 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.

 

The Summit Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $240,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-12.

 
The firm is in a 30 percent tax bracket and has a cost of capital of 5 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

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 $66,000. 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.

 

Assume a corporation has earnings before depreciation and taxes of $106,000, depreciation of $44,000, and that it has a 40 percent tax bracket.

 

A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $370,000 a year for the next 40 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 5 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 11 percent.


What is the difference between the present value of the settlement at 5 percent and 11 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

a. If the firm has $31 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
 
b. The 5.6 percent cost of debt referred to earlier applies only to the first $22 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

 

The aftertax cost of debt is 8.50 percent; the cost of preferred stock is 12.00 percent; and the cost of common equity (in the form of retained earnings) is 15.50 percent.

 

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects.

Historically, the corporation’s earnings and dividends per share have increased about 9.4 percent annually and this should continue in the future. Northwest’s common stock is selling at $76 per share, and the company will pay a $9.60 per share dividend (D1).

The company’s $120 preferred stock has been yielding 9 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock.


The company’s optimum capital structure is 40 percent debt, 20 percent preferred stock, and 40 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest.

 

Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 8 percent annual interest and has 17 years remaining to maturity. The current yield to maturity on similar bonds is 11 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

 

BioScience Inc. will pay a common stock dividend of $4.60 at the end of the year (D1). The required return on common stock (Ke) is 17 percent. The firm has a constant growth rate (g) of 7 percent.

 

Ecology Labs Inc. will pay a dividend of $3.90 per share in the next 12 months (D1). The required rate of return (Ke) is 22 percent and the constant growth rate is 10 percent. (Each question is independent of the others.)

 

Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 30-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:

 

Barry’s Steroids Company has $1,000 par value bonds outstanding at 14 percent interest. The bonds will mature in 40 years.

 

Question 
Barry’s Steroids Company has $1,000 par value bonds outstanding at 14 percent interest. The bonds will mature in 50 years.
 

If the percent yield to maturity is 11 percent, what percent of the total bond value does the repayment of principal represent? Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Refer to Table 10-1, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) decline from 12 percent to 6 percent.
 

a. What is the bond price at 12 percent?

 

b. What is the bond price at 6 percent?

 

c. What would be your percentage return on investment if you bought when rates were 12 percent and sold when rates were 6 percent? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 35-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point as described below:
 

Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 30 years remaining until maturity.

 

Compute the new price of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

 

Question 
Katie Pairy Fruits Inc. has a $3,200, 24-year bond outstanding with a nominal yield of 17 percent (coupon equals 17% × $3,200 = $544 per year). Assume that the current market required interest rate on similar bonds is now only 12 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.    
 

a. Compute the current price of the bond. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

 

b. Find the present value of 5 percent × $3,200 (or $160) for 24 years at 12 percent. The $160 is assumed to be an annual payment. Add this value to $3,200. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

 

Question 
Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 4 percent annual interest and has 18 years remaining to maturity. The current yield to maturity on similar bonds is 12 percent.
 

a. What is the current price of the bonds? Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

 

b. By what percent will the price of the bonds increase between now and maturity? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
You are called in as a financial analyst to appraise the bonds of Olsen’s Clothing Stores. The $1,000 par value bonds have a quoted annual interest rate of 10 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 15 years to maturity. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.
 

a. Compute the price of the bonds based on semiannual analysis. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

b. With 10 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

Question 
BioScience Inc. will pay a common stock dividend of $6.40 at the end of the year (D1). The required return on common stock (Ke) is 14 percent. The firm has a constant growth rate (g) of 5 percent.
 

Compute the current price of the stock (P0). (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

Question 
Ecology Labs Inc. will pay a dividend of $5.30 per share in the next 12 months (D1). The required rate of return (Ke) is 19 percent and the constant growth rate is 8 percent. (Each question is independent of the others.)   
 

a. Compute the price of Ecology Labs' common stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

b. Assume Ke, the required rate of return, goes up to 23 percent. What will be the new price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

c. Assume the growth rate (g) goes up to 13 percent. What will be the new price? Ke goes back to its original value of 19 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

d. Assume D1 is $7.00. What will be the new price? Assume Ke is at its original value of 19 percent and g goes back to its original value of 8 percent. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

Question 
Justin Cement Company has had the following pattern of earnings per share over the last five years:   
 

The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings.     

 

a. Project earnings and dividends for the next year (20X6). (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answers to 2 decimal places.)

 

b. If the required rate of return (Ke) is 13 percent, what is the anticipated stock price (P0) at the beginning of 20X6? (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answer to 2 decimal places.)

 

Question 
Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 5 percent over the next four years. The required rate of return is 12 percent (this will also serve as the discount rate in this problem). Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
 

a. Compute the anticipated value of the dividends for the next four years. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)

 

b. Calculate the present value of each of the anticipated dividends at a discount rate of 12 percent. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)

 

c. Compute the price of the stock at the end of the fourth year (P4). (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

d. Calculate the present value of the year 4 stock price at a discount rate of 12 percent. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

e. Compute the current value of the stock. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

f. Use the formula given below to show that it will provide approximately the same answer as part e. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)    

 

g. If current EPS were equal to $5.51 and the P/E ratio is 1.2 times higher than the industry average of 10, what would the stock price be? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

h. By what dollar amount is the stock price in part g different from the stock price in part f? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

 

Question 
Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 10 percent return and can be financed at 7 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a 17 percent return but would cost 19 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital structure.
 

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

 

b. Which project(s) should be accepted?

 

Question 
A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $210,000 a year for the next 20 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 15 percent.
 

What is the difference between the present value of the settlement at 4 percent and 15 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

Question
The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 7 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 15 percent higher; that is, firms that paid 9 percent for debt last year will be paying 10.35 percent this year.
 

a. If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 15 percent increase? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. If the receipts of the foundation were found to be taxable by the IRS (at a rate of 25 percent because of involvement in political activities), what would the aftertax cost of debt be? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Airborne Airlines Inc. has a $1,000 par value bond outstanding with 15 years to maturity. The bond carries an annual interest payment of $114 and is currently selling for $880. Airborne is in a 35 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
 

a. Compute the yield to maturity on the old issue and use this as the yield for the new issue. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. Make the appropriate tax adjustment to determine the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Terrier Company is in a 35 percent tax bracket and has a bond outstanding that yields 9 percent to maturity.
 

a. What is Terrier’s aftertax cost of debt? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. Assume that the yield on the bond goes down by 1 percentage point, and due to tax reform, the corporate tax rate falls to 20 percent. What is Terrier’s new aftertax cost of debt? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

c. Has the aftertax cost of debt gone up or down from part a to part b?

 

Question 
Keyspan corp. is planning to issue debt that will mature in 2,030. In many respects, the issue is similar to the currently outstanding debt of the corporation. Use Table 11-3.
 

a. Calculate the yield to maturity on similarly outstanding debt for the firm, in terms of maturity. (Input your answer as a percent rounded to 2 decimal places.)

 

Assume that because the new debt wil be issued at par, the required yield to maturity will be .16 percent higher than the value determined in part a.

 

b. What is the new yield to maturity? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

c. If the firm is in a 40 percent tax bracket, what is the aftertax cost of debt for the yield determined in part b? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Wallace Container Company issued $100 par value preferred stock 10 years ago. The stock provided a 7 percent yield at the time of issue. The preferred stock is now selling for $63.
 

What is the current yield or cost of the preferred stock? (Disregard flotation costs.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 4 percent less than that for preferred stock.
 

Debt can be issued at a yield of 10.0 percent, and the corporate tax rate is 40 percent. Preferred stock will be priced at $58 and pay a dividend of $5.40. The flotation cost on the preferred stock is $5.

 

a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

c. Based on the facts given above, is the treasurer correct?

 

Question 
Compute Ke and Kn under the following circumstances:
 

a. D1 = $7.80, P0 = $108, g = 3%, F = $6.00. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

b. D1 = $.42, P0 = $37, g = 6%, F = $2.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

c. E1 (earnings at the end of period one) = $13, payout ratio equals 20 percent, P0 = $45, g = 8.9%, F = $4.40. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

d. D0 (dividend at the beginning of the first period) = $7, growth rate for dividends and earnings (g) = 5%, P0 = $71, F = $7. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 

Question 
Global Technology’s capital structure is as follows:
 

The aftertax cost of debt is 7.50 percent; the cost of preferred stock is 11.50 percent; and the cost of common equity (in the form of retained earnings) is 14.50 percent.

 

Calculate the Global Technology’s weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

Question 
Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:
 

a-1. Compute the weighted average cost for four plans. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

a-2. Which of the four plans has the lowest weighted average cost of capital?

 

b. What is the relationship between the various types of financing costs and the debt-to-equity ratio?

 

Question 
A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.

The preferred stock is selling at $84 per share and pays a dividend of $8.00 per share. The corporate tax rate is 30 percent. The flotation cost is 3.0 percent of the selling price for preferred stock. The optimal capital structure for the firm is 25 percent debt, 20 percent preferred stock, and 55 percent common equity in the form of retained earnings.
The company currently has outstanding a bond with a 11.0 percent coupon rate and another bond with an 8.6 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 11.9 percent. The common stock has a price of $64 and an expected dividend (D1) of $1.84 per share. The historical growth pattern (g) for dividends is as follows:
 

The preferred stock is selling at $84 per share and pays a dividend of $8.00 per share. The corporate tax rate is 30 percent. The flotation cost is 3.0 percent of the selling price for preferred stock. The optimal capital structure for the firm is 25 percent debt, 20 percent preferred stock, and 55 percent common equity in the form of retained earnings.

 

a. Compute the historical growth rate. (Do not round intermediate calculations. Round your answer to the nearest whole percent and use this value as g. Input your answer as a whole percent.)

 

b. Compute the cost of capital for the individual components in the capital structure. (Use the rounded whole percent computed in part a for g. Do not round any other intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

c. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

Question 
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 30 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects.
 

Historically, the corporation’s earnings and dividends per share have increased about 5.2 percent annually and this should continue in the future. Northwest’s common stock is selling at $61 per share, and the company will pay a $3.50 per share dividend (D1).

 

The company’s $90 preferred stock has been yielding 5 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $3.00 for preferred stock.

 

The company’s optimal capital structure is 40 percent debt, 15 percent preferred stock, and 45 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest.

 

a. Compute the cost of debt, Kd (use the accompanying table—relate to the utility bond credit rating for yield.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

Question 
Delta Corporation has the following capital structure:
 

a. If the firm has $51 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

 

b. The 10.6 percent cost of debt referred to earlier applies only to the first $18 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

 

Question 
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 45 percent debt, 20 percent preferred stock, and 35 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 6.2 percent; preferred stock, 9 percent; retained earnings, 8 percent; and new common stock, 9.2 percent.
 

a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke.) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

 

b. If the firm has $28 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

 

c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 35 percent of the capital structure, but will all be in the form of new common stock, Kn.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

d. The 6.2 percent cost of debt referred to earlier applies only to the first $9 million of debt. After that, the cost of debt will be 8.5 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

 

e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

Question 
Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity).
 

a. Compute Ki (required rate of return on common equity based on the capital asset pricing model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

b. Compute Ke (required rate of return on common equity based on the dividend valuation model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

 

 

Question 
Assume a corporation has earnings before depreciation and taxes of $110,000, depreciation of $48,000, and that it has a 30 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 $16,000 in depreciation? All other factors are the same.

 

c. How much cash flow is lost due to the reduced depreciation from $48,000 to $16,000?

 

Question 
The Short-Line Railroad is considering a $205,000 investment in either of two companies. The cash flows are as follows:
 

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?

 

Question 
X-treme Vitamin Company is considering two investments, both of which cost $11,000. The cash flows are as follows:
 

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?

 

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?

 

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

 

Question 
You buy a new piece of equipment for $28,808, and you receive a cash inflow of $3,700 per year for 14 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.)

 

Question 
Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $52,000. The annual cash inflows for the next three years will be:
 

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?

 

Question 
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 $51,000. 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.
 

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?

 

Question 
Turner Video will invest $88,500 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.
 

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.)

 

c. Which investment assumption is better?

 

Question 
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.
 

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 9 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 9 percent?

 

Question 
Telstar Communications is going to purchase an asset for $580,000 that will produce $280,000 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 30 percent tax bracket.
 

Question 
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.
 

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?

 

Question 
An asset was purchased three years ago for $190,000. It falls into the five-year category for MACRS depreciation. The firm is in a 30 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 $22,060. (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 $70,060. (Input all amounts as positive values. Do not round intermediate calculations and round your answers to whole dollars.)

 

Question 
DataPoint Engineering is considering the purchase of a new piece of equipment for $280,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $180,000 in nondepreciable working capital. Forty-five thousand dollars 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.
 

The tax rate is 30 percent. The cost of capital must be computed based on the following:

 

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?

 

Question 
Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $66,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $28,800. A new piece of equipment will cost $156,000. 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.
 

The firm’s tax rate is 40 percent and the cost of capital is 9 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?

 

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

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

 

b. Which project will you select?

 

Question 
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:
 

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.)

 

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

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

 

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

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

 

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

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?

 

Question 
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.
 

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

 

a-2. Which 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?

 

Question 
Waste Industries is evaluating a $56,500 project with the following cash flows.  
 

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?

 

Question 
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 8 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 12 percent. Either method will require an initial capital outlay of $99,000. The inflows from projected business over the next five years are shown next.  
 

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?

 

Question 
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 $22,400. 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 12 percent. Use Appendix D for an approximate answer but calculate your final answers using the formula and financial calculator methods.
 

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?

 

Question 
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 $1,609,000 and will produce $370,000 per year in years 5 through 15 and $538,000 per year in years 16 through 25. The U.S. gold mine will cost $2,032,000 and will produce $312,000 per year for the next 25 years. The cost of capital is 5 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 3 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?