Lindsey was recently hired by Swift Ltd. as a junior budget analyst. She is working for the Venture Capital Division and has been given for capital budgeting projects to evaluate. She must give her analysis and recommendation to the capital budgeting committee.

Lindsey has a B.S. in accounting from CWU (2014) and passed the CPA exam (2017). She has been in public accounting for several years. During that time she earned an MBA from Seattle U. She would like to be the CFO of a company someday--maybe Swift Ltd.-- and this is an opportunity to get onto that career track and to prove her ability.

As Lindsey looks over the financial data collected, she is trying to make sense of it all. She already has the most difficult part of the analysis complete -- the estimation of cash flows. Through some internet research and application of finance theory, she has also determined the firm’s beta.

Here is the information that Lindsey has accumulated so far:

The Capital Budgeting Projects

She must choose one of the four capital budgeting projects listed below:  

Table 1

Table 1 shows the expected after-tax operating cash flows for each project. All projects are expected to have a 4 year life. The projects differ in size (the cost of the initial investment), and their cash flow patterns are different. They also differ in risk as indicated in the above table.

The capital budget is $20 million and the projects are mutually exclusive.

Capital Structures

Swift Ltd. has the following capital structure, which is considered to be optimal:

Cost of Capital

Lindsey knows that in order to evaluate the projects she will have to determine the cost of capital for each of them. She has been given the following data, which he believes will be relevant to her task.

(1)The firm’s tax rate is 35%.

(2) Swift Ltd. has issued a 8% semi-annual coupon bond with 14 years term to maturity. The current trading price is $960.

(3) The firm has issued some preferred stock which pays an annual 8.5% dividend of $50 par value, and the current market price is $52.

(4) The firm’s stock is currently selling for $35 per share. Its last dividend (D₀) was $2.00, and dividends are expected to grow at a constant rate of 5%. The current risk free return offered by Treasury security is 2.8%, and the market portfolio’s return is 10.80%. Swift Ltd. has a beta of 1.1. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 3.5%.

(5) The firm adjusts its project WACC for risk by adding 2.5% to the overall WACC for high-risk projects and subtracting 2.5% for low-risk projects.

Lindsey knows that Swift Ltd. executives have favored IRR in the past for making their capital budgeting decisions. Her professor at Seattle U. said NPV was better than IRR. Her textbook says that MIRR is also better than IRR.   She is the new kid on the block and must be prepared to defend her recommendations.

First, however, Lindsey must finish the analysis and write her report. To help begin, she has formulated the following questions:

1. What is the firm’s cost of debt?

2. What is the cost of preferred stock for Swift Ltd.?

3. Cost of common equity

(1) What is the estimated cost of common equity using the CAPM approach?

(2) What is the estimated cost of common equity using the DCF approach?

(3) What is the estimated cost of common equity using the bond-yield-plus-risk-premium approach?

(4) What is the final estimate for r_s?

4. What is Swift Ltd.’s overall WACC?

5. Do you think the firm should use the single overall WACC as the hurdle rate for each of its projects? Explain.

6. What is the WACC for each project? Place your numerical solutions in Table 2.

7. Calculate all relevant capital budgeting measures for each project, and place your numerical solutions in Table 2.

Table 2

8. Comment on the commonly used capital budgeting measures. What is the underlying cause of ranking conflicts? Which criterion is the best one, and why?

9. Which of the projects are unacceptable and why?

10. Rank the projects that are acceptable, according to Lindsey’s criterion of choice.

11. Which project should Lindsey recommend and why? Explain why each of the projects not chosen was rejected.

Instructions

1.Your answers should be Word processed, submitted via Canvas.

2.Questions 5, 8, 9, and 11 are discussion questions.

3.Place your numerical solutions in Table 2.

4.Show your steps for calculation questions.

Your employer has just transferred you to beautiful Winnipeg. Since you anticipate being at the branch here for some time, you have decided to purchase a condo downtown. The condo you want to purchase is being listed at $385,000. The mortgage officer at your financial institution has informed you that the current rate on mortgages is 4.80%, compounded semi‐annually. Fortunately, you are a prudent saver and have managed to amass the 10% down payment in your savings account. You have decided to take the mortgage on an 18‐year amortization period hoping that this will keep the every second week (26 payments/year) payments manageable.

1. What is your bi-weekly (every second week) interest rate for this mortgage? (1 mark)

2. What is the bi‐weekly payment for this mortgage

3. What is the effective per annum interest rate that you are paying on this mortgage? (1 mark)

4. How much of your first payment will be principal?

5. If your employer moves you again in 4 years and you must sell your condo, how much principal do you still owe the bank?

a.NAL?

b.Maximum lease payment?

Porsche is expected to sell approximately 60,000 cars in the U.S. in 2019. I'll let you estimate an average selling price across Porsche models. For this example, let's assume that all the sales happen in December of 2019. Also, assume that Porsche has fully hedges their U.S. dollar exposure (based on predicted sales) using futures or forward contracts at a rate of $1.10 per Euro. What happens in the following situations:

a. the Dollar/Euro exchange rate remains unchanged and sales are as predicted

b. the Euro rises against the Dollar and the exchange rate moves to $1.00 per Euro. Sales are as predicted.

c. the Euro falls against the Dollar and the exchange rate moves to $1.25 per Euro. Sales are as predicted.

d. the Euro rises against the Dollar and the exchange rate moves to $1.00 per Euro. Sales are 20% higher than expected.

e. the Euro rises against the Dollar and the exchange rate moves to $1.00 per Euro. Sales are 20% lower than expected.

Be specific in your answers. Where does Porsche lose money, and how much? Where does Porsche make money and how much? What is the overall effect on Porsche's income in their home currency? FYI, you can make the Euro currency symbol in Word by using CRTL + ALT + E.  

1. A property will generate NOI of $12,000 per year for each of the next 8 years. You purchase this property at a 5% cap rate. If you expect to sell this property in 6 years at a terminal cap rate of 6%, what is you IRR?

While the operating budget process is underway in June, the capital budget process must also begin. Describe what should be happening in the capital budget

1. You are considering a property that will cost $54,200 today.  NOI from the property is expected to be $20,608 each year for the next five years.  Also, at the end of the fifth year, you expect you can sell the property for $13,200.  What is the property’s IRR?

Alset Inc. hires you as a consultant, manufacturers of fine personalized drone. The market for

drones is growing quickly. The firm purchased some land three years ago for $1.44 million

expecting to use it as a toxic waste dump site. Few months ago Alset Inc. hired another firm to

dispose of all toxic materials. Based on a recent appraisal, the firm believes the current market

value of the land for $1.54 million on an after-tax basis. In four years, the land could be sold for

$1.64 million after taxes. The land will be utilized for the project.

The firm also hired a marketing firm to analyze the personalized drone market, at a cost of

$129,000. An excerpt of the marketing report is as follows:

The flying car industry will have a rapid expansion in the next four years. With the brand name

recognition that Alset brings to bear, we feel that the company will be able to sell 4,200, 5,100,

5,700, and 4,600 units each year for the next four years, respectively. Again, capitalizing on the

name recognition of Alset, we feel that a premium price of $690 can be charged for each

personalized drone. Because these drones appear to be a fad, we feel at the end of the four-year

period, sales should be discontinued.

Alset believes that fixed costs for the project will be $445,000 per year, and variable costs are 10

percent of sales. The equipment necessary for production will cost $3.9 million and will be

depreciated according to a three-year MACRS schedule. At the end of the project, the equipment

can be scrapped for $420,000. Net working capital of $129,000 will be required immediately.

Alset has a 40 percent tax rate, and the required return on the project is 14 percent.

Three year MACRS Schedule

Recovery Year

3-Year

1. 33.33%

2. 44.45%

3. 14.81%

4. 7.41%

1. What is the NPV of the project? Based on the NPV would you accept or reject this project?

2. What is the IRR of the project? Based on the IRR would you accept or reject this project?

3. What is the discounted payback? Based on the discounted payback would you accept or reject

this project?

Changing cash conversion cycle   Camp Manufacturing turns over its inventory 55 times each​ year, has an average payment period of 3636 days, and has an average collection period of 5959 days. The firm has annual sales of $3.9 million and the cost of goods sold of​ $2.2million.  ​(Use a​ 365-day year.)

a.  Calculate the​ firm's operating cycle and cash conversion cycle.

b.  What is the dollar value of inventory held by the​ firm?

c.  If the firm could reduce the average age of its inventory from 73

days to 63 days, by how much would it reduce its dollar investment in working​ capital?

BC Co.’s assets consist of $20 thousands in cash and three investment projects. The firm hasno debt outstanding. The company can borrow and lend at 12% per year. Each project lasts foronly one year. The table below lists the cash flows from the projects at the initial date (t= 0)and at the end of the year (t= 1). Cash outflows are listed as negative numbers, while cashinflows are listed as positive. All figures are in thousands of dollars.

0 1

Project x -200 +240

Project y +100 -134

Project z -100 +108

1. Calculate the Internal Rate of Return (IRR) of each project.

2. Which projects should the firm invest in and why?

3. How much would you pay today, before any investments have been made, to buy this

firm?

Old World Charm, Inc. specializes in selling scented candles. The company has established a policy of reordering inventory every other month (which is 6 times per year). A recently employed MBA has considered New England's inventory problem from the EOQ model viewpoint. If the following constitute the relevant data, what is the extra total cost of the current policy compared with the total cost of the optimal policy? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box. Ordering cost = $10 per order Carrying cost = 20% of purchase price Purchase price = $15 per unit Total sales for year = 1,000 units Safety stock = 0

1.What is Capital Asset Pricing Model (CAPM)? What is it used for ?

a) There have been discussions about how useful the Capital Asset Pricing Model (CAPM), does it actually work or is "beta dead"?

b) Why is the model important in Finance ?

Multiple Choice

• $59.73

• $64.71

• $18.67

• $59.32

• $62.22

Examine the key reasons why a business may not want to hold too much or too little working capital. Provide examples that illustrate the consequences of either situation.

You have looked at the current financial statements for Reigle Homes, Co. The company has an EBIT of $2,850,000 this year. Depreciation, the increase in net working capital, and capital spending were $225,000, $90,000, and $415,000, respectively. You expect that over the next five years, EBIT will grow at 16 percent per year, depreciation and capital spending will grow at 21 percent per year, and NWC will grow at 11 percent per year. The company has $15,100,000 in debt and 345,000 shares outstanding. You believe that sales in five years will be $22,600,000 and the price-sales ratio will be 2.4. The company’s WACC is 8.5 percent and the tax rate is 21 percent.