FIN 650 PROBLEM SET 2

After-Tax Cost of Debt

LL Incorporated’s currently outstanding 7% coupon bonds have a yield to maturity of 4.7%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 25%, what is LL’s after-tax cost of debt? Round your answer to two decimal places.

Cost of Equity: Dividend Growth

Summerdahl Resort’s common stock is currently trading at $22 a share. The stock is expected to pay a dividend of $2.25 a share at the end of the year (D1 = $2.25), and the dividend is expected to grow at a constant rate of 3% a year. What is the cost of common equity? Round your answer to two decimal places.

Cost of Equity: CAPM

Booher Book Stores has a beta of 0.7. The yield on a 3-month T-bill is 3% and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 15%. What is the estimated cost of common equity using the CAPM? Round your answer to two decimal places.

WACC

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company’s outstanding bonds is 10%, and the company’s tax rate is 25%. Ortiz’s CFO has calculated the company’s WACC as 10.8%. What is the company’s cost of equity capital? Round your answer to the nearest whole number.

%

NPV

A project has an initial cost of $50,000, expected net cash inflows of $11,000 per year for 9 years, and a cost of capital of 14%. What is the project’s NPV? (*Hint:* Begin by constructing a time line.) Do not round intermediate calculations. Round your answer to the nearest cent.

IRR

A project has an initial cost of $55,000, expected net cash inflows of $10,000 per year for 11 years, and a cost of capital of 11%. What is the project’s IRR? Round your answer to two decimal places.

%

MIRR

A project has an initial cost of $45,000, expected net cash inflows of $14,000 per year for 7 years, and a cost of capital of 12%. What is the project’s MIRR? (*Hint:* Begin by constructing a time line.) Do not round intermediate calculations. Round your answer to two decimal places.

Profitability Index

A project has an initial cost of $35,000, expected net cash inflows of $9,000 per year for 8 years, and a cost of capital of 10%. What is the project’s PI? (*Hint:* Begin by constructing a time line.) Do not round intermediate calculations. Round your answer to two decimal places.

Payback

A project has an initial cost of $50,000, expected net cash inflows of $15,000 per year for 7 years, and a cost of capital of 11%. What is the project’s payback period? Round your answer to two decimal places.

years

Discounted Payback

A project has an initial cost of $52,125, expected net cash inflows of $12,000 per year for 7 years, and a cost of capital of 12%. What is the project’s discounted payback period? (*Hint:* Begin by constructing a time line.) Do not round intermediate calculations. Round your answer to two decimal places.

years

NPVs, IRRs, and MIRRs for Independent Projects

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 | ||

$5,100 | $7,500 | |||

5,100 | 7,500 | |||

5,100 | 7,500 | |||

5,100 | 7,500 | |||

5,100 | 7,500 |

Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept/reject decision for each. Do not round intermediate calculations. Round the monetary values to the nearest dollar and percentage values to two decimal places. Use a minus sign to enter negative values, if any.

Truck | Pulley | ||||

Value | Decision | Value | Decision | ||

IRR | % | % | |||

NPV | $ | $ | |||

MIRR | % | % |

Investment Outlay

Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $16 million, and production and sales will require an initial $1 million investment in net operating working capital. The company’s tax rate is 25%. Enter your answers as a positive values. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places.

- What is the initial investment outlay?

$ million

- The company spent and expensed $150,000 on research related to the new project last year. What is the initial investment outlay?

$ million

- 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 $1.3 million after taxes and real estate commissions. What is the initial investment outlay?

$ million

Project Cash Flow

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 | $20 million |

Operating costs (not including depreciation) | $8 million |

Depreciation | $4 million |

Interest expense | $4 million |

The company faces a 25% tax rate. What is the project’s operating cash flow for the first year (t = 1)? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as $1,200,000. Round your answer to the nearest dollar.

$

Net Salvage ValueAllen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $13.8 million, of which 70% has been depreciated. The used equipment can be sold today for $4.6 million, and its tax rate is 25%. What is the equipment’s after-tax net salvage value? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.$ |

Replacement Analysis

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 $116,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $20,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 11%, and its marginal tax rate is 25%. Should Chen buy the new machine? Do not round intermediate calculations. Round your answer to the nearest cent. Negative value, if any, should be indicated by a minus sign.

NPV: $

Chen purchase the new machine.

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $820,000, and it would cost another $22,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $453,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $16,500. The sprayer would not change revenues, but it is expected to save the firm $372,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 25%. (Ignore the half-year convention for the straight-line method.) Cash outflows, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

- What is the Year-0 net cash flow?

$

- What are the net operating cash flows in Years 1, 2, and 3?Year 1:$ Year 2:$ Year 3:$
- What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)?

$

- If the project’s cost of capital is 12%, what is the NPV of the project?

$

Should the machine be purchased?

AFN equation

Broussard Skateboard’s sales are expected to increase by 20% from $8.4 million in 2019 to $10.08 million in 2020. Its assets totaled $4 million at the end of 2019.

Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2019, 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 7%, and the forecasted payout ratio is 65%. Use the AFN equation to forecast Broussard’s additional funds needed for the coming year. Enter your answer in dollars. For example, an answer of $1.2 million should be entered as $1,200,000. Do not round intermediate calculations. Round your answer to the nearest dollar.

$

Projected Operating Assets

Berman & Jaccor Corporation’s current sales and partial balance sheet are shown below.

This year | ||||

Sales | 1,000 | |||

Balance Sheet: Assets | ||||

Cash | 200 | |||

Short-term investments | 105 | |||

Accounts receivable | 150 | |||

Inventories | 250 | |||

Total current assets | 705 | |||

Net fixed assets | 450 | |||

Total assets | 1,155 |

Sales are expected to grow by 10% next year. Assuming no change in operations from this year to next year, what are the projected total operating assets? Do not round intermediate calculations. Round your answer to the nearest dollar.