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Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for $2.8 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $5.9 million on an aftertax basis. In five years, the aftertax value of the land will be $6.3 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $32.5 million to build. The following market data on DEI’s securities are current: |
| Debt: |
240,000 bonds with a coupon rate of 5.9 percent outstanding, 22 years to maturity, selling for 104 percent of par; the bonds have a $1,000 par value each and make semiannual payments. |
| Common stock: |
9,400,000 shares outstanding, selling for $72.80 per share; the beta is 1.25. |
| Preferred stock: |
460,000 shares of 3.7 percent preferred stock outstanding, selling for $82.75 per share. The par value is $100. |
| Market: |
5.9 percent expected market risk premium; 2.8 percent risk-free rate. |
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DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 6.5 percent on new common stock issues, 4 percent on new preferred stock issues, and 2 percent on new debt issues. Wharton has included all direct and indirect issuance costs (along with its profit) in setting these spreads. Wharton has recommended to DEI that it raise the funds needed to build the plant by issuing new shares of common stock. DEI’s tax rate is 21 percent. The project requires $1,450,000 in initial net working capital investment to get operational. Assume DEI raises all equity for new projects externally and that the NWC does not require floatation costs.. |
| a. |
Calculate the project’s initial Time 0 cash flow, taking into account all side effects. |
| b. | The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +1.0 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI’s project. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
| c. | The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation to a zero salvage value. At the end of the project (that is, the end of Year 5), the plant and equipment can be scrapped for $5.1 million. What is the aftertax salvage value of this plant and equipment? |
| d. | The company will incur $7,400,000 in annual fixed costs. The plan is to manufacture 19,525 RDSs per year and sell them at $11,060 per machine; the variable production costs are $9,675 per RDS. What is the annual operating cash flow (OCF) from this project? |
| e. | DEI’s comptroller is primarily interested in the impact of DEI’s investments on the bottom line of reported accounting statements. What will you tell her is the accounting break-even quantity of RDSs sold for this project? |
| f. |
Finally, DEI’s president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project’s internal rate of return (IRR) and net present value (NPV) are. |
In: Finance
A firm has determined its optimal capital structure, which is comprised of the following sources and target market value proportions:
Source of capital target market proportions
Long term debt 30%
Preferred stock 5
Common stock equity 65
Debt: The firm can sell a 20-year, $1000 par value, 9 percent bond for $970. Interest is payable annually.
Preferred Stock: The firm has determined it can issue preferred stock at $65 per share. The stock will pay an $8.00 annual dividend.
Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $3.00. Its dividend payments have been growing at a constant rate of 5%.
Additionally, the firm’s marginal tax rate is 40 percent.
What are the firm’s after-tax cost of debt, cost of preferred stock, cost of common stock, and the weighted average cost of capital? Please show work.
In: Finance
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Pearl Corp. is expected to have an EBIT of $1,900,000 next year. Depreciation, the increase in net working capital, and capital spending are expected to be $160,000, $80,000, and $120,000, respectively. All are expected to grow at 15 percent per year for four years. The company currently has $10,000,000 in debt and 800,000 shares outstanding. At Year 5, you believe that the company's sales will be $13,620,000 and the appropriate price-sales ratio is 2.1. The company’s WACC is 8.4 percent and the tax rate is 21 percent. |
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What is the price per share of the company's stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
In: Finance
Moody Farms just paid a dividend of $2.65 on its stock. The growth rate in dividends is expected to be a constant 3.8 percent per year indefinitely. Investors require a return of 15 percent for the first three years, a return of 13 percent for the next three years, and a return of 11 percent thereafter. What is the current share price?
In: Finance
In: Finance
You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $70,000, and it would cost another $14,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $35,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $6,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $66,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 35%.
In: Finance
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Dinklage Corp. has 9 million shares of common stock outstanding. The current share price is $81, and the book value per share is $7. The company also has two bond issues outstanding. The first bond issue has a face value of $130 million, a coupon rate of 6 percent, and sells for 92 percent of par. The second issue has a face value of $115 million, a coupon rate of 5 percent, and sells for 103 percent of par. The first issue matures in 24 years, the second in 10 years. |
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Suppose the most recent dividend was $4.85 and the dividend growth rate is 5.2 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 22 percent. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
In: Finance
You must evaluate a proposal to buy a new milling machine. The base price is $200,000, and shipping and installation costs would add another $7000. The machine falls into the MACRS 3-year class,and it would be sold after 3 years for $120,000. The applicable depreciation rates are 33,45,15, and 7 percent. The machine would require a $10,000 increase in working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pre-tax labor costs would decline by $45,000 per year. The marginal tax rate is 35 percent, and the WACC is 13 percent. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.
a. How should the $5,000 spent last year be handled?
b. What is the net cost of the machine for capital budgeting purposes, that is, the year 0 project cash flow?
c. What are the net operating cash flows during Years 1,2,and 3?
d. Should the machine be purchased?
In: Finance
Colsen Communications is trying to estimate the first-year net operating cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:
| Sales revenues | $25 million |
| Operating costs (excluding depreciation) | 17.5 million |
| Depreciation | 5 million |
| Interest expense | 5 million |
The company has a 40% tax rate, and its WACC is 14%.
Write out your answers completely. For example, 13 million should be entered as 13,000,000.
In: Finance
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You are the financial analyst for a tennis racket manufacturer. The company is considering using a graphitelike material in its tennis rackets. The company has estimated the information in the following table about the market for a racket with the new material. The company expects to sell the racket for 5 years. The equipment required for the project will be depreciated on a straight-line basis and has no salvage value. The required return for projects of this type is 14 percent and the company has a 25 percent tax rate. |
| Pessimistic | Expected | Optimistic | |||||||||||
| Market size | 115,000 | 125,000 | 137,000 | ||||||||||
| Market share | 18 | % | 22 | % | 24 | % | |||||||
| Selling price | $ | 165 | $ | 170 | $ | 174 | |||||||
| Variable costs per unit | $ | 108 | $ | 104 | $ | 101 | |||||||
| Fixed costs per year | $ | 980,000 | $ | 925,000 | $ | 895,000 | |||||||
| Initial investment | $ | 1,675,000 | $ | 1,525,000 | $ | 1,505,000 | |||||||
| Calculate the NPV for each case for this project. Assume a negative taxable income generates a tax credit. (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) |
In: Finance
In 2017, BMC Software generated $465M of operating income (earnings before interest and taxes) and $295M of net income from $2,200M of sales. Over the next two years (2018 and 2019), the firm is projecting 10% growth in operating income and 5% growth in depreciation expense. Beginning in 2020, BMC estimates that free cash flows will grow 2%. Assume the firm’s effective tax rate is 30%, weighted average cost of capital is 9%, and number of shares outstanding is 146M. Depreciation expense for 2017 was $105M while capital expenditures were $55M. Capital expenditures are expected to remain constant over the next 5 years. BMC expects working capital needs to increase by $20M per year. Lastly, the firm has $250M in cash and cash equilavents and $750M of interest bearing debt. What is the present value of the terminal value today (2018)? and Using the DCF approach, which of the following is the best estimate of BMC Software’s equity per share in 2018?
BMC Software is considering adding an additional $250M in debt and repurchasing the firm’s equity with the proceeds. If the stock is current worth $50 per share, how many shares would the firm have to repurchase?
In: Finance
1. Braun Industries is considering an investment project which has the following cash flows:
Year project cash flows
0 -$1000
1 500
2 600
3 700
4 400
The company’s WACC is 10 percent. What is the project’s payback, discounted payback, internal rate of return, modified internal rate of return, and net present value? show work.
In: Finance
The future earnings, dividends, and common stock price of Callahan Tech Inc. are expected to grow 6% per year. Callahan’s common stock currently sells for $22/share, its last dividend was $2; and it will pay a $2.12 dividend at the end of the current year (same as early next year – this is your D1).
• If the firm’s beta is 1.2, the risk-free rate is 6%, and the average return on the market is 13%, what will be the firm’s cost of common equity using the CAPM approach?
• If the firm’s bonds earn a return of 11%, based on the bond-yield- plus-premium approach, what will be the cost of common equity? (Use the mid-point range for risk premium. That is the risk premium is 4%, which is in the middle of the range of risk premium going from 3% - 5%)
• If you have equal confidence in the inputs used for the three approaches, what is your estimate for Callahan’s cost of common equity?
In: Finance
Johnson Communications is trying to estimate the Year 1
operating cash flow for a proposed project. The assets required for
the project were fully depreciated at the time of purchase. The
financial staff has collected the following information:
| Sales revenues |
$8.8 million |
| Operating costs |
4.8 million |
| Interest expense |
1.1 million |
Johnson has also determined that this project would cannibalize one
of its other projects by $1.4 million of cash flow (before taxes)
per year. The firm has a 30 percent tax rate, and its WACC is 10
percent. Calculate the project’s operating cash flow for Year
1.
| a. |
$1,820,000 |
|
| b. |
$2,030,000 |
|
| c. |
$1,050,000 |
|
| d. |
$–40,000 |
|
| e. |
$2,800,000 |
In: Finance
• Total investment: 100K
• Invested 30K in stock A, with three past returns: 5%, 6%, and 7%.
• Invested the rest in stock B, with three past returns: 1%, 11%, and 21%.
• What is the variance and standard deviation of your portfolio, if correlation between stock A and B is o.5?
In: Finance