Description

Problem Set 2 Questions:

  1. LL Incorporated’s currently outstanding 7% coupon bonds have a yield to maturity of 13%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is LL’s after-tax cost of debt? Round your answer to two decimal places.
  1. Summerdahl Resort’s common stock is currently trading at $34.00 a share. The stock is expected to pay a dividend of $2.75 a share at the end of the year (D1 = $2.75), and the dividend is expected to grow at a constant rate of 7% a year. What is the cost of common equity? Round your answer to two decimal places.
  1. Booher Book Stores has a beta of 1.3. The yield on a 3-month T-bill is 3% and the yield on a 10-year T-bond is 7%. The market risk premium is 7%, and the return on an average stock in the market last year was 14%. What is the estimated cost of common equity using the CAPM? Round your answer to two decimal places.
  1. David Ortiz Motors has a target capital structure of 30% debt and 70% equity. The yield to maturity on the company’s outstanding bonds is 11%, and the company’s tax rate is 40%. Ortiz’s CFO has calculated the company’s WACC as 10.13%. What is the company’s cost of equity capital? Round your answer to two decimal places.
  1. A project has an initial cost of $43,900, expected net cash inflows of $11,000 per year for 7 years, and a cost of capital of 10%. What is the project’s NPV? (Hint: Begin by constructing a time line.) Do not round your intermediate calculations. Round your answer to the nearest cent.
  1. A project has an initial cost of $60,000, expected net cash inflows of $14,000 per year for 9 years, and a cost of capital of 14%. What is the project’s IRR? Round your answer to two decimal places.
  1. A project has an initial cost of $35,225, expected net cash inflows of $14,000 per year for 6 years, and a cost of capital of 11%. What is the project’s MIRR? Do not round intermediate calculations. Round your answer to two decimal places.
  1. A project has an initial cost of $45,275, expected net cash inflows of $15,000 per year for 8 years, and a cost of capital of 11%. What is the project’s PI? Do not round your intermediate calculations. Round your answer to two decimal places.
  1. A project has an initial cost of $54,725, expected net cash inflows of $10,000 per year for 7 years, and a cost of capital of 12%. What is the project’s payback period? Round your answer to two decimal places.
  1. A project has an initial cost of $60,000, expected net cash inflows of $14,000 per year for 7 years, and a cost of capital of 13%. What is the project’s discounted payback period? Round your answer to two decimal places.
  1. Edelman 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 cash outlay for the truck is $15,000 and that for the pulley system is $21,000. The firm’s cost of capital is 11%. After-tax cash flows, including depreciation, are as follows:

Year

Truck

Pulley

1

$5,100

$7,500

2

5,100

$7,500

3

5,100

$7,500

4

5,100

$7,500

5

5,100

$7,500

a. Calculate the IRR for each project. Round your answers to two decimal places.

Truck:

What is the correct accept/reject decision for this project?

Pulley:

b. Calculate the NPV for each project. Round your answers to the nearest dollar, if necessary. Enter each answer as a whole number. For example, do not enter 1,000,000 as 1 million.

Truck:

What is the correct accept/reject decision for this project?

Pulley:

What is the correct accept/reject decision for this project?

c. Calculate the MIRR for each project. Round your answers to two decimal places.

Truck:

What is the correct accept/reject decision for this project?

Pulley:

What is the correct accept/reject decision for this project?

  1. Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $15 million, and production and sales will require an initial $4 million investment in net operating working capital. The company’s tax rate is 30%.
  1. What is the initial investment outlay? Write out your answer completely. For example, 2 million should be entered as 2,000,000.
  1. The company spent and expensed $150,000 on research related to the new project last year. Would this change your answer? (yes or no)
  1. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer?The project’s cost will (increase, decrease or not change)
  1. The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service:

Projected Sales

$25 million

Operating costs (not including depreciation)

$9 million

Depreciation

$6 million

Interest expense

$5 million

The company faces a 40% tax rate. What is the project’s operating cash flow for the first year (t = 1)? Write out your answer completely. For example, 2 million should be entered as 2,000,000.

14. Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $20 million, of which 85% has been depreciated. The used equipment can be sold today for $7 million, and its tax rate is 35%. What is the equipment’s after-tax net salvage value? Write out your answer completely. For example, 2 million should be entered as 2,000,000.

15. Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $40,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $8,300 per year. It would have zero salvage value at the end of its life. The Project cost of capital is 9%, and its marginal tax rate is 35%. Should Chen buy the new machine?

16. The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $980,000, and it would cost another $16,500 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $536,000. The machine would require an increase in net working capital (inventory) of $12,000. The sprayer would not change revenues, but it is expected to save the firm $369,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 35%.

a. What is the Year 0 net cash flow?

b. What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.

Year 1 $

Year 2 $

Year 3 $

c. What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)? Do not round intermediate calculations. Round your answer to the nearest dollar.

d. If the project’s cost of capital is 14 %, what is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar.

Should the machine be purchased? (yes/no)

17. Broussard Skateboard’s sales are expected to increase by 25% from $9.0 million in 2016 to $11.25 million in 2017. Its assets totaled $3 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%, and the forecasted payout ratio is 75%. Use the AFN equation to forecast Broussard’s additional funds needed for the coming year. Round your answer to the nearest dollar. Do not round intermediate calculations.

18. Broussard Skateboard’s sales are expected to increase by 20% from $8.6 million in 2016 to $10.32 million in 2017. Its assets totaled $4 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%, and the forecasted payout ratio is 55%. What would be the additional funds needed? Do not round intermediate calculations. Round your answer to the nearest dollar.