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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 $4.6 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 $7.7 million on an aftertax basis. In five years, the aftertax value of the land will be $8.1 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 $29.8 million to build. The following market data on DEI’s securities are current: |
| Debt: |
185,000 bonds with a coupon rate of 7.7 percent outstanding, 25 years to maturity, selling for 107 percent of par; the bonds have a $2,000 par value each and make semiannual payments. |
| Common stock: |
11,200,000 shares outstanding, selling for $78.20 per share; the beta is 1.25. |
| Preferred stock: |
550,000 shares of 5.5 percent preferred stock outstanding, selling for $87.25 per share. The par value is $100. |
| Market: |
6.3 percent expected market risk premium; 4.6 percent risk-free rate. |
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DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 7 percent on new common stock issues, 4.5 percent on new preferred stock issues, and 2.5 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 24 percent. The project requires $1,900,000 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. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) |
| 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 +2.5 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 $6.9 million. What is the aftertax salvage value of this plant and equipment? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) |
| d. | The company will incur $9,200,000 in annual fixed costs. The plan is to manufacture 21,250 RDSs per year and sell them at $11,240 per machine; the variable production costs are $10,125 per RDS. What is the annual operating cash flow (OCF) from this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) |
| 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? (Do not round intermediate calculations and round your answer to nearest whole number, e.g., 32.) |
| 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. (Do not round intermediate calculations. Enter your NPV in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89. Enter your IRR as a percent rounded to 2 decimal places, e.g., 32.16.) |
In: Finance
| Income Statement | 2008 | 2009 | ||
| Total Market (lawns professionally treated) | 45,000 | 43,000 | ||
| LR Lawns Treated (unit volume) | 11,000 | 12,000 | ||
| Sales Revenue | $ 860,000 | $ 885,000 | ||
| Memo: Market Share | 24% | 28% | ||
| Memo: Avg. Revenue/Lawn | $ 78 | $ 74 | ||
| Less: Variable Cost of Sales Revenue | ||||
| Chemicals | $ 115,000 | $ 125,000 | ||
| 1099 Workers * | $ 175,000 | $ 182,000 | ||
| Truck Running Costs | $ 40,000 | $ 40,000 | ||
| Total Cost of Sales Revenue | $ 330,000 | $ 347,000 | ||
| = Gross Profit Margin | $ 530,000 | $ 538,000 | ||
| Memo: Gross Profit Margin % | 38% | 39% | ||
| Less: Overhead (Other Operating) Expenses: | ||||
| Salaried Employees | $ 190,000 | $ 180,000 | ||
| Office and Warehouse rent | $ 90,000 | $ 90,000 | ||
| Depreciation of Trucks | $ 30,000 | $ 40,000 | ||
| Advertising | $ 30,000 | $ 40,000 | ||
| Total Overhead Expenses | $ 340,000 | $ 350,000 | ||
| = EBIT (net operating income) | $ 190,000 | $ 188,000 | ||
| less: Interest Expense | $ 23,000 | $ 35,000 | ||
| = Pretax Income (profit) | $ 167,000 | $ 153,000 | ||
| less: Income taxes | $ 40,000 | $ 35,000 | ||
| = Net Income (profit) | $ 127,000 | $ 118,000 | ||
| Memo: Profit Margin % | 15% | 13% | ||
| Balance Sheet | ||||
| Cash | $ 5,000 | $ 5,000 | ||
| Accounts Receivable | $ 25,000 | $ 40,000 | ||
| Inventories | $ 8,000 | $ 9,000 | ||
| = Current Assets | $ 38,000 | $ 54,000 | ||
| Fixed Assets | $ 500,000 | $ 550,000 | ||
| - Accumulated Depreciation | $ 80,000 | $ 120,000 | ||
| = Net Fixed Assets | $ 420,000 | $ 430,000 | ||
| Total Assets | $ 458,000 | $ 484,000 | ||
| Accounts Payable | $ 8,000 | $ 20,000 | ||
| Bank Loans | $ 275,000 | $ 300,000 | ||
| = Total Liabilities | $ 283,000 | $ 320,000 | ||
| Common Stock (Invested capital) | $ 100,000 | $ 100,000 | ||
| Retained Earnings | $ 75,000 | $ 64,000 | ||
| Total Liabilities and Owner's Equity | $ 458,000 | $ 484,000 | ||
| * Workers are paid based upon the number of lawns treated (not hourly). | ||||
Please calculate the following for 2009:
a) Return on Assets:
b) Current Ratio:
c) Debt/Equity Ratio:
d) Cash flow from Operations:
e) Cash flow from Investing Activities:
f) Cash Flow from Financing Activities:
g) Net Change in Cash for the year:
In: Finance
NPV unequal lives. Singing Fish Fine Foods has $2,000,000 for capital investments this year and is considering two potential projects for the funds. Project 1 is updating the store's deli section for additional food service. The estimated after-tax cash flow of this project is $600,00 per year for the next five years. Project 2 is updating the store's wine section. The estimated annual after-tax cash flow for this project is $530,000 for the next six years. If the appropriate discount rate for the deli expansion is 9.5% and the appropriate discount rate for the wine section is 9.0% use the NPV to determine which project Singing Fish should choose for the store. Adjust the NPV for unequal lives with the equivalent annual annuity. Does the decision change? If the appropriate discount rate for the deli expansion is 9.5%, what is the NPV of the deli expansion? blank $ (Round to the nearest cent.).
In: Finance
d) Given the short-sale rules, what is the no-arbitrage bond for the stock-futures price relationship? That is, given a stock index of 1,900, how high and how low can the futures price be without giving rise to arbitrage opportunities?
In: Finance
5. Cochrane, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2.40 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,250,000 in annual sales, with costs of $1,240,000. The project requires an initial investment in net working capital of $160,000, and the fixed asset will have a market value of $185,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 10 percent.
a. What are the net cash flows of the project?
b. What is NPV & IRR? Decision?
In: Finance
At an output level of 9,000 units, you have calculated that the degree of operating leverage is 1.3. The operating cash flow is $15,300 in this case.
a. Ignoring the effect of taxes, what are fixed costs?
b. What will the operating cash flow be if output rises to 10,500 units?
c. What will the operating cash flow be if output falls to 7,000 units?
In: Finance
There are two alternative ways of building and operating a project.
A. The government borrows, builds, and operates the project. Because it is considered the risk-free borrower, the government has a comparative advantage in borrowing, and it can borrow at the risk-free rate of 1%. It will cost the government $200 million to build the project in Year 0 and the project will generate a cash flow of $3 million for infinity.
B. A private enterprise, whose weighted average cost of capital is 5%, has a comparative advantage in building and operating the project. It can build the project for $150 million in Year 0 and generate a cash flow of $12.5 million for infinity.
Questions:
1. (10 points) How much are the NPV and IRR of Alternative A? How much are the NPV and IRR of Alternative B?
2 (10 points) If only one of the two alternatives can be chosen, which one should be chosen? Explain fully, with supporting calculations.
3. (10 points) Suggest a way of building and operating the project that would be even better than choosing either A or B. Explain fully, with supporting calculations.
In: Finance
Suppose you have two bonds. The first one is a 1 year zero coupon bond. It pays 1 at maturity and its price is 0.98 today. The second bond is a two year zero coupon bond that pays 1 at maturity and which price is 0.95 today.
a. What is the term structure of interest rate?
b. What is the duration and modified duration in these bonds?
c. What is the price movement in every bond after a 1% increase in the yield?
In: Finance
Background: Jane owns the typical personal automobile policy Assume that each accident, as described in the following scenarios, occurred separately. The actual cash value of Jane's car is $17,400. The policy has the following limits: A (liability) = $100,000 B (medical payments) = $3,000 C (uninsured motorists)= $100,000 D (damage to your auto) = $250 deductible - collision; $250 deductible - other-than-collision Scenario #1: While using her car as a delivery vehicle for a local orchard, Jane was struck by an uninsured motorist. She had $10,000 in medical expenses and lost wages. Her car was totaled (the replacement value is $14,500). Scenario #2: Jane ran a stop sign and collided with a parked car, causing $3,250 of damage to each vehicle. Scenario #3: Jane hit a deer on a country road. Her car was a total loss. Scenario #4: Jane borrowed her neighbor's car for a week, while the neighbor was on vacation. While driving the neighbor's car, Jane ran into a pole and caused $4,000 of damage to the neighbor's car. Illustrate your calculations for determining your final answers and briefly explain how you arrived at these answers
In: Finance
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Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $100 per barrel and the land is believed to contain 528,000 barrels of oil. If found, the oil would cost $107 million to extract. Treasury bills that mature in one year yield a continuously compounded interest rate of 5 percent and the standard deviation of the returns on the price of crude oil is 55 percent. |
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Use the Black-Scholes model to calculate the maximum bid that the company should be willing to make at the auction. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) |
In: Finance
Capital Budgeting
Social Circle Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follow:
|
Year |
Sound Cellar |
Pro Gamer |
|
1 |
65,000 |
70,000 |
|
2 |
60,000 |
55,000 |
|
3 |
25,000 |
35,000 |
|
4 |
25,000 |
30,000 |
|
5 |
45,000 |
30,000 |
|
Total |
220,000 |
220,000 |
Each product requires an investment of $125,000. A rate of 10% has been selected for the net present value analysis.
In: Finance
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A company has a single zero coupon bond outstanding that matures in five years with a face value of $28 million. The current value of the company’s assets is $21 million and the standard deviation of the return on the firm’s assets is 44 percent per year. The risk-free rate is 3 percent per year, compounded continuously. |
| a. |
What is the current market value of the company’s equity? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| b. | What is the current market value of the company’s debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| c. | What is the company’s continuously compounded cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
| d. | The company has a new project available. The project has an NPV of $1,700,000. If the company undertakes the project, what will be the new market value of equity? Assume volatility is unchanged. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| e. | Assuming the company undertakes the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
In: Finance
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Jared Lazarus has just been named the new chief executive officer of BluBell Fitness Centers, Inc. In addition to an annual salary of $415,000, his three-year contract states that his compensation will include 18,750 at-the-money European call options on the company’s stock that expire in three years. The current stock price is $49 per share and the standard deviation of the returns on the firm’s stock is 60 percent. The company does not pay a dividend. Treasury bills that mature in three years yield a continuously compounded interest rate of 4 percent. Assume that the annual salary payments occur at the end of the year and that these cash flows should be discounted at a rate of 12 percent. |
| 1)Use the Black-Scholes model to calculate the value of the stock options. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
| 2)Determine the total value of the compensation package on the date the contract is signed. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) |
In: Finance
Explain in 2 to 3 lines.
1.When we open a position, the costs are different between an options contract and a futures contract. Explain the difference between a premium and a margin account. Be sure to explain the various types of margins that are required and what costs each type of contract has.
2.Explain the idea of the "cost of carry" as it applies to futures contracts. Specifically, what factors can influence the difference between a spot and futures/forward price in the cost of carry? Now explain "convergence" as it relates to spot and futures prices as well as the cost of carry.
In: Finance
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FINANCIAL LEVERAGE EFFECTS Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $15 million in invested capital, has $3.75 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 55% and pays 12% interest on its debt, whereas LL has a 30% debt-to-capital ratio and pays only 10% interest on its debt. Neither firm uses preferred stock in its capital structure.
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In: Finance