finance questions 57

17-1. Find the net present value (NPV) and profitability index (PI) of a

project that costs \$1,500 and returns \$800 in year one and \$850 in

year two. Assume the project’s cost of capital is 8 percent.

17-5. For the following projects, compute NPV, IRR, MIRR, PI, and

payback. If these projects are mutually exclusive, which one(s)

should be done? If they are independent, which one(s) should be

undertaken?

i. A B C D

Year 0 2 1,000 2 1,500 2 500 2 2,000

Year 1 400 500 100 600

Year 2 400 500 300 800

Year 3 400 700 250 200

Year 4 400 200 200 300

Discount rate 10% 12% 15% 8%

17-6. The Sanders Electric Company is evaluating two projects for

possible inclusion in the firm’s capital budget. Project M will

require a \$37,000 investment while project O’s investment will be

\$46,000. After-tax cash inflows are estimated as follows for the two

projects:

YEAR PROJECT M PROJECT O

1 \$12,000 \$10,000

2 12,000 10,000

3 12,000 15,000

4 12,000 15,000

5 15,000

a. Determine the payback period for each project.

b. Calculate the NPV and PI for each project based on a 10

percent cost of capital. Which, if either, of the projects is

acceptable?

c. Determine the IRR and MIRR for Projects M and O.

17-10. A machine can be purchased for \$10,500, including transportation

charges, but installation costs will require \$1,500 more. The

machine is expected to last four years and produce annual cash revenues

of \$6,000. Annual cash operating expenses are expected to be

\$2,000, with depreciation of \$3,000 per year. The firm has a 30

percent tax rate. Determine the relevant after-tax cash flows and

prepare a cash flow schedule.

17-11. Use the information in Problem 10 to do the following:

a. Calculate the payback period for the machine.

b. If the project’s cost of capital is 10 percent, would you

c Estimate the IRR for the machine.

18-3. Stern’s Stews, Inc., is considering a new capital structure. Its

current and proposed capital structures are the following:

CURRENT PROPOSED

Total assets \$150 million \$150 million

Debt 25 million 100 million

Equity 125 million 50 million

Common stock price \$50 \$50

Number of shares 2,500,000 1,000,000

Interest rate 12% 12%

Stern’s Stews’ president expects next year’s EBIT to be \$20 million, but

it may be 25 percent higher or lower. Ignoring taxes, perform an EBIT/

eps analysis. What is the indifference level of earnings before interest

and taxes? Should Stern’s Stews change its capital structure? Why?

18-7. Here are the income statements for Genatron Manufacturing

Corporation for 2013 and 2014:

INCOME STATEMENT 2013 2014

Net sales \$1,300,000 \$1,500,000

Cost of goods sold 780,000 900,000

Gross profit \$520,000 \$600,000

Marketing expenses 130,000 150,000

Depreciation 40,000 53,000

Interest 45,000 57,000

Earnings before taxes \$155,000 \$190,000

Income taxes 62,000 76,000

Net income \$93,000 \$114,000

Assuming one-half of the general and administrative expenses are fixed

costs, estimate Genatron’s DOL, DFL, and DCL in 2013 and 2014.

18-8. The Nutrex Corporation wants to calculate its weighted average

cost of capital (WACC). Its target capital structure weights are 40

percent long-term debt and 60 percent common equity. The before tax

cost of debt is estimated to be 10 percent and the company is in

the 40 percent tax bracket. The current risk-free interest rate is 8

percent on Treasury bills. The expected return on the market is 13

percent and the firm’s stock beta is 1.8.

a. What is Nutrex’s cost of debt?

b. Estimate Nutrex’s expected return on common equity using

the security market line (SML).

c. Calculate the after-tax weighted average cost of capital (WACC).

18-9. The following are balance sheets for the Genatron Manufacturing

Corporation for the years 2013 and 2014:

BALANCE SHEET 2013 2014

Cash \$50,000 \$40,000

Accounts receivable 200,000 260,000

Inventory 450,000 500,000

Total current assets 700,000 800,000

Fixed assets (net) 300,000 400,000

Total assets \$1,000,000 \$1,200,000

Bank loan, 10% \$90,000 \$ 90,000

Accounts payable 130,000 170,000

Accruals 50,000 70,000

Total current liabilities \$270,000 \$330,000

Long-term debt, 12% 300,000 400,000

Common stock, \$10 par 300,000 300,000

Capital surplus 50,000 50,000

Retained earnings 80,000 120,000

Total liabilities and equity \$1,000,000 \$1,200,000

a. Calculate the WACC based on book value weights. Assume an

after-tax cost of new debt of 8.63 percent and a cost of

common equity of 16.5 percent.

b. The current market value of Genatron’s long-term debt is

\$350,000. The common stock price is \$20 per share and

30,000 shares are outstanding. Calculate the WACC using

market value weights and the component capital costs in (a).

c. Recalculate the WACC based on book value and market

value weights assuming the before-tax cost of debt will be

18 percent, the company is in the 40 percent income tax

bracket, and the after-tax cost of common equity capital is

21 percent.