B&B Technologies is considering expanding its operations to include production and sales of high capacity storage devices. The assistant to the CFO has collected a lot of information which is described below. Unfortunately, some of the information may be of questionable relevance, but that is for you to decide. You have asked to present a net present value based analysis to help management decide on the desirability of getting into the storage device business.

The company owns a vacant building near its current manufacturing facility; this building could be used for the expansion, or it could be leased to an interested customer and generate a lease revenue of $250,000, starting this year. The firm could increase the lease charge by 5% every year. The company has some unused equipment that has a book value of $40,000 zero and a market value of $30,000. This equipment could either be sold or be modified to produce storage devices; the modification would cost $10,000. The old equipment and modification costs would be depreciated straight-line over five years. Producing storage devices would also require the purchase of new equipment costing $900,000. For purposes of depreciation, the new equipment would be in the 7-year MACRS class. This equipment would have a useful life of six years, at the end of which it would have a scrap value of 10% of the purchase price.

Producing storage devices would require an ongoing investment in working capital. Net working capital is expected to be 10% of expected sales for the coming year and would vary with sales, but remain at 10% of expected sales for the coming year. All working capital would be recovered at the end of the six-year life of the investment.

The production facility is expected to generate sales revenues of $1,000,000 in the first year; sales are expected to increase at 10% p.a. for three years and then decline by 5% p.a. over the last two years of the project. Operating costs are expected to be 40% of sales. The firm’s effective tax rate of 20% is expected to remain unchanged over the planning period, and the appropriate required rate of return for this investment is 8%.

Question

1. Estimate the net present value and the internal rate of return for this investment.

2. Now suppose the following changes occur: (i) Sales in the first year turn out to be $900,000, (ii) the CGS to sales ratio is 45%, (iii) the NWC to sales ratio is 15%, (iv) the scrap value of the new equipment in year 6 is 5% of the original cost, and (v) the required rate of return is 10%. What is the net present value and the internal rate of return with all of the above changes? Should B&B Technologies get into the storage device business?

Assume Chalktronics is for sale for $500,000 and the firm has the following characteristics:

            Cash sales: $600,000 per year forever

            Cash costs: 70% of sales

            Corporate tax rate: 40%

            Unlevered cost of capital (r₀): 20%

Both Pentronics and DebtTronics are interested in purchasing Chalktronics.

Pentronics will use no debt financing and DebtTronics will use a target D/E ratio of 10% to finance the acquisition.

A.  What is the maximum Pentronics can pay for Chalktronics? (4 pts.)

B.  What is the maximum DebtTronics can pay for Chalktronics? (4 pts.)

Calculation of individual costs and WACC   Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following​ weights: 50​% ​long-term debt, 15​% preferred​ stock, and 35​% common stock equity​ (retained earnings, new common​ stock, or​ both). The​ firm's tax rate is 21​%. Debt The firm can sell for ​$1030 a 19​-year, ​$1 comma 000​-par-value bond paying annual interest at a 9.00​% coupon rate. A flotation cost of 3​% of the par value is required. Preferred stock  7.50​% ​(annual dividend) preferred stock having a par value of ​$100 can be sold for ​$88. An additional fee of ​$4 per share must be paid to the underwriters. Common stock  The​ firm's common stock is currently selling for ​$50 per share. The stock has paid a dividend that has gradually increased for many​ years, rising from ​$2.50 ten years ago to the ​$4.07 dividend​ payment, Upper D 0​, that the company just recently made. If the company wants to issue new new common​ stock, it will sell them ​$2.00 below the current market price to attract​ investors, and the company will pay ​$2.50 per share in flotation costs.  

a.  Calculate the​ after-tax cost of debt.

b.  Calculate the cost of preferred stock.

c.  Calculate the cost of common stock​ (both retained earnings and new common​ stock).

d.  Calculate the WACC for Dillon Labs.

B3. Use the foreign exchange model to explain the impact of an increase in US interest rates on the Australian dollar?

B4. Use the per worker production function to explain why additional capital per worker cannot be a source of long run economic growth in an economy

A European call option and a European put option on a stock both have a strike price of $45 and expire in 6 months. Currently, the stock price is $48.11 and the put price is $4.11. The risk-free rate is 2% per annum continuous compounding. Calculate the CALL price.

The Quick Buck Company is an all-equity firm that has been in existence for the past three years. Company management expects that the company will last for two more years and then be dissolved. The firm will generate cash flows of $550,000 next year and $840,000 in two years, including the proceeds from the liquidation. There are 20,000 shares of stock outstanding and shareholders require a return of 12 percent.

1. What is the current price per share of the stock?

2. The board of directors is dissatisfied with the current dividend policy and proposes that a dividend of $650,000 be paid next year. To raise the cash necessary for the increased dividend, the company will sell new shares of stock. How many shares of stock must be sold? What is the new price per share of the existing shares of stock?

An engineer has two investment options to choose from:

a. Broker A is asking the engineer to invest $10,000 now for five years and earn 12% interest rate compounded monthly for the first three years and 15% compounded semi-annually the last two years

b. Broker A is asking the engineer to invest $10,000 now for five years and earn 10% interest rate compounded monthly for the first two years and 17% compounded quarterly for the last three years.

Which option would you recommend?

c. Following discussions with some investment bankers, the engineer is informed that she could earn at least $12,000 profit on her $10,000 in five years. Prepare a counter offer for your selected broker by estimating a combination of interest rates (and compounding periods) that will earn approximately $12,000 (+ - 10%).

Finance - CFIN 6th Edition Chapter 14, Problem 12 Solution

I am not able to come up with the same solution posted in the Chegg Study Textbook solution for this question beginning with step 4 of 7. The issue has to do with computing the EAR. I followed the textbook solution, but the response does not make sense for the EAR. Please help.

Chapter 14 Problem 12

Montana Allied Products (MAP) must borrow $1.7 million to finance its working capital requirements. The bank has offered a 45-day simple interest loan with a quoted interest rate of 8 percent. Calculate the loan’s APR and assuming there is (a) no compensating balance requirement and (b) a 15 percent compensating balance requirement, which MAP must satisfy from the loan proceeds. (c) How much does MAP have to borrow so that it has $1.7 million to pay its bills if the loan requires a 15 percent compensating balance?

The formula and the solution provided does not match up

(1+8/360)^8-1

Part A

Part B

A call option has an exercise price of $60 and matures in three months. The current stock price is $64, and the risk-free rate is 5 percent per year, compounded continuously. What is the price of the call if the standard deviation of the stock is 0 percent per year?

Part C

A 35-year maturity bond has a 6% coupon rate, paid annually. It sells today for $937.42. A 25-year maturity bond has a 5.5% coupon rate, also paid annually. It sells today for $949.5. A bond market analyst forecasts that in five years, 30-year maturity bonds will sell at yields to maturity of 7% and that 20-year maturity bonds will sell at yields of 6.5%. Because the yield curve is upward-sloping, the analyst believes that coupons will be invested in short-term securities at a rate of 5%.

a. Calculate the expected rate of return of the 35-year bond over the five-year period. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. What is the expected return of the 25-year bond? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explain the step in constructing an incremental budget and why one should be employed. Explain the strengths and weaknesses of an incremental budget and how a manager can unnecessarily increase or pad his or her budget?

rev: 09_20_2012

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