A company is considering purchasing some new machinery. Collectively, the acquisition cost would be $3.72 million plus a transportation charge of $94,0000 to get the machinery to the plant. To better engineer the production flow, $450,000 was spent to pay a production consultant. Special electrical service would be required, that and related (required) plant upgrades will be $124,000. Training of the production workers costing $34,000 is also necessary. An increase in inventory of $75,000 is needed, to supply these raw materials our vendor is requiring that we reduce our account payables by $22,000. The now superior widgets that we will be manufacturing will be able to command a premium of $1,470,000 per year but manufacturing costs will increase by $270,000. The machinery has an economic life of 4 years and will be depreciated to zero using the straight line depreciation method. The machinery is expected to be sold at the end for $180,000. The company is taxed at 32% and can raise capital at a cost of 8%.

(a) What is the project’s initial cash outflow?

(b) What is the project’s operating cash flow per year?

(c) What is the project’s terminating cash flow?

BUSI 320 Comprehensive Problem 3 FALL 2019

Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1:   Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $ 10,000 today.   

Option B: Receive a $1500 gift each year for the next 10 years. The first $1400 would be

     received 1 year from today.                     

Option C: Receive a one-time gift of $18,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 3% annually for the next 10 years.    Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 6% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

      Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 9% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________ today.

       Option C would be worth $__________ today.

       Financial theory supports choosing Option _______

Decision #2: Planning for Retirement

Erich and Mallory are 22, newly married, and ready to embark on the journey of life.   They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing $3000 per year to prepare for retirement. Mallory just told Erich, though, that she had heard that they would actually have more money the day they retire if they put $3000 per year away for the next 10 years - and then simply let that money sit for the next 35 years without any additional payments – then they would have MORE when they retired than if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do).   Please help Erich and Mallory make an informed decision:   

Assume that all payments are made at the END a year (or month), and that the rate of return on all yearly investments will be 7.2% annually.  

(Please do NOT ROUND when entering “Rates” for any of the questions below)

1. How much money will Erich and Mallory have in 45 years if they do nothing for the next 10 years, then put $3000 per year away for the remaining 35 years?

2. How much money will Erich and Mallory have in 10 years if they put $3000 per year away for the next 10 years?

b2) How much will the amount you just computed grow to if it remains invested for the remaining

35 years, but without any additional yearly deposits being made?

3. How much money will Erich and Mallory have in 45 years if they put $3000 per year away for each of the next 45 years?

How much money will Erich and Mallory have in 45 years if they put away $250

4. per MONTH at the end of each month for the next 45 years? (Remember to adjust 7.2% annual rate to a Rate per month!)

5. If Erich and Mallory wait 25 years (after the kids are raised!) before they put anything away for retirement, how much will they have to put away at the end of each year for 20 years in order to have $1,000,000 saved up on the first day of their retirement 45 years from today?

Atlas Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0. Project S has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and 2, respectively. Project L has an expected life of 4 years with after-tax cash inflows of $4,373 at the end of each of the next 4 years. Each project has a WACC of 9.25%, and Project S can be repeated with no changes in its cash flows. The controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is selected over Project S, i.e., what is the value of NPVL - NPVS?

If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected rate of return is reduced so it may not meet the firm's hurdle rate for acceptance of the project. The second approach involves adjusting the cost of common equity as follows:

The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment.

Quantitative Problem: Barton Industries expects next year's annual dividend, D₁, to be $1.50 and it expects dividends to grow at a constant rate g = 4.8%. The firm's current common stock price, P₀, is $20.00. If it needs to issue new common stock, the firm will encounter a 5.4% flotation cost, F. What is the flotation cost adjustment that must be added to its cost of retained earnings? Do not round intermediate calculations. Round your answer to two decimal places.

%

What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places.

%

Locate an article or website that addresses business plan development and/or management. Identify and explain a key recommendation from this source that was not addressed in Chapter 25: Putting It All Together: Creating a Business Plan That Is Strategic. For example, you may explain ways to manage a budget or how to conduct a market analysis. You also can explain a technical tool (e.g., software) used for budgeting a business — not for personal finances. Be sure to cite your source.

You manage an equity fund with an expected risk premium of 10.4% and a standard deviation of 18%. The rate on Treasury bills is 5%. Your client chooses to invest $45,000 of her portfolio in your equity fund and $55,000 in a T-bill money market fund. What is the reward-to-volatility (Sharpe) ratio for the equity fund? (Round your answer to 4 decimal places.)

Sunland’s Candles will be producing a new line of dripless candles in the coming years and has the choice of producing the candles in a large factory with a small number of workers or a small factory with a large number of workers. Each candle will be sold for $10. If the large factory is chosen, the cost per unit to produce each candle will be $3.00. The cost per unit will be $7.50 in the small factory. The large factory would have fixed cash costs of $2.5 million and a depreciation expense of $300,000 per year, while those expenses would be $510,000 and $100,000, respectively in the small factory.

Calculate the accounting operating profit break-even point for both factory choices for Sunland’s Candles. (Round answers to nearest whole units, e.g. 152.)

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 4%. The probability distribution of the risky funds is as follows:

The correlation between the fund returns is 0.12.

You require that your portfolio yield an expected return of 12%, and that it be efficient, on the best feasible CAL.

a. What is the standard deviation of your portfolio? (Round your answer to 2 decimal places.)

b. What is the proportion invested in the T-bill fund and each of the two risky funds? (Round your answers to 2 decimal places.)

Many American businesses that use corporate structures choose to incorporate in Delaware even if they are physically based in another state. Legally, why might a business from, say, New York choose to be a Delaware corporation rather than just a New York Corporation? Explain.

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 8%. The probability distribution of the risky funds is as follows:

The correlation between the fund returns is 0.10.

Solve numerically for the proportions of each asset and for the expected return and standard deviation of the optimal risky portfolio. (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.)

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 5%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation

Stock fund (S) 17% 30%

Bond fund (B) 11 22

The correlation between the fund returns is 0.10.

What is the Sharpe ratio of the best feasible CAL?

You find the following corporate bond quotes. To calculate the number of years until maturity, assume that it is currently January 15, 2016. The bonds have a par value of $2,000.

What price would you expect to pay for the Kenny Corp. bond? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Price            $

What is the bond’s current yield? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Current yield       6.09      %