There are primary and secondary decision tools when evaluating capital expenditure projects. What are some of the considerations that a finance manager should take into account when deciding whether the firm should embark on a project and why?

Ch. 8 - 4

Assume​ you've generated the following information about the stock of​ Ben's Banana​ Splits: The​ company's latest dividends of ​$1.62 a share are expected to grow to ​$1.77 next​year, to ​$1.93 the year after​ that, and to ​$2.10 in year 3. After​ that, you think dividends will grow at a constant 7% rate.

a. Use the variable growth version of the dividend valuation model and a required return of 12​% to find the value of the stock.

b. Suppose you plan to hold the stock for three​ years, selling it immediately after receiving the ​$2.10 dividend. What is the​ stock's expected selling price at that​ time? As in part a​,

assume a required return of 12​%.

c. Imagine that you buy the stock today paying a price equal to the value that you calculated in part a. You hold the stock for three​ years, receiving dividends as described above. Immediately after receiving the third​ dividend, you sell the stock at the price calculated in part b. Use the IRR approach to calculate the expected return on the stock over three years. Could you have guessed what the answer would be before doing the​ calculation?

d. Suppose the​ stock's current market price is actually ​$35.35.

Based on your analysis from part a​, is the stock overvalued or​ undervalued?

e. A friend of yours agrees with your projections of​ Ben's Banana Splits future​ dividends, but he believes that in three​ years, just after the company pays the ​$2.10 ​dividend, the stock will be selling in the market for ​$53.42. Given that​ belief, along with the​ stock's current market price from part d​, calculate the return that your friend expects to earn on the stock over the next three years.

Yerba Industries is an​ all-equity firm whose stock has a beta of 0.60 and an expected return of 11%. Suppose it issues new​ risk-free debt with a 4.5% yield and repurchase 35% of its stock. Assume perfect capital markets.

a. What is the beta of Yerba stock after this​ transaction?

b. What is the expected return of Yerba stock after this​ transaction?

Suppose that prior to this​ transaction, Yerba expected earnings per share this coming year of $0.50​, with a forward​ P/E ratio​ (that is, the share price divided by the expected earnings for the coming​ year) of 14.

c. What is​ Yerba's expected earnings per share after this​ transaction? Does this change benefit the​ shareholder? Explain.    

d. What is​ Yerba's forward​ P/E ratio after this​ transaction? Is this change in the​ P/E ratio​ reasonable? Explain.

1. Calculate sales given the following data. Total fixed assets $400,000; long-term liabilities $155,000; total liabilities $280,000; total shareholders' equity $320,000; net working capital turnover 20.

$1,500,000

$1,700,000

$1,900,000

$2,100,000

$2,250,000

2.Calculate the value of total assets given the following information: total equity = $630; total debt ratio = .30.

$189

$375

$527

$750

$900

3.What is the net addition to cash given the information below?

Decrease in inventory = $5,250
Increase in accounts receivable = $7,650
Decrease in net fixed assets = $9,150
Increase in accounts payable = $6,250
Decrease in notes payable = $8,750
Increase in long-term debt = $8,500
Decrease in retained earnings = $1,150
Increase in common stock = $5,550

$11,650

$17,150

−$11,650

−$17,150

−$23,450

4.Calculate depreciation expense given the following information. Interest expense $2,000; times interest earned 5; cash coverage ratio 5.5.

$1,000

$1,200

$1,400

$1,600

$1,800

5.Given the following information, determine the total average tax rate for an Ontario resident earning $100,000 in employment income.

42.16%

37.16%

27.31%

20.05%

15%

In​ mid-2015, Qualcomm Inc. had ​$15 billion in​ debt, total equity capitalization of ​$87 ​billion, and an equity beta of 1.32 ​(as reported on​ Yahoo! Finance). Included in​ Qualcomm's assets was​$25 billion in cash and​ risk-free securities. Assume that the​ risk-free rate of interest is 2.9% and the market risk premium is 3.9%.

a. What is​ Qualcomm's enterprise​ value?

b. What is the beta of​ Qualcomm's business​ assets?

c. What is​ Qualcomm's WACC?

TAX RATE WAS NEVER MENTIONED PERIOD.

explain the importance of distinguishing between variable and fixed costs?

Mercer Corp. has 10 million shares outstanding and ​$147 million worth of debt outstanding. Its current share price is $63. ​Mercer's equity cost of capital is 8.5%. Mercer has just announced that it will issue ​$300 million worth of debt. It will use the proceeds from this debt to pay off its existing​ debt, and use the remaining ​$153 million to pay an immediate dividend. Assume perfect capital markets.

a. Estimate​ Mercer's share price just after the recapitalization is​ announced, but before the transaction occurs.

b. Estimate​ Mercer's share price at the conclusion of the transaction. ​(Hint​: Use the market value balance​ sheet.)

c. Suppose​ Mercer's existing debt was​ risk-free with a 4.64% expected​ return, and its new debt is risky with a 5.03%expected return. Estimate​ Mercer's equity cost of capital after the transaction.

You are planning to save for retirement over the next 35 years. To do this, you will invest £400 a month in a share account and £500 a month in a bond account. The annual return of the share account is expected to be 7 per cent, and the bond account will pay 4 per cent annually. When you retire, you will combine your money into an account with a 6 per cent annual return.

How much can you withdraw each month from your account, assuming a 25-year withdrawal period?

1. (a) £7,585.

2. (b) £8,650.

3. (c) £9,000.

4. (d) £9,985.

5. (e) I choose not to answer.

. Replacement decision

The electronics company plans to replace the manually operated manufacturing machine with a new fully automated machine. Use the following information to determine the cash flows and profitability of the replacement decision.

Current situation

• Current estimated wages of operators are 30,000 annually. By replacing, we can save these labour related costs.

• Maintenance costs € 8,000 per year.

• Waste related costs of € 10,000 per year

• The machine currently in use was bought 5 years ago for 60,000 euros. The company can continue to operate this machine for the next five years. The company applies linear depreciation and both the book and market values are zero after five years.

• The potential sales price of the old machine today is € 20,000

Project under consideration

• Required capital investment is € 120,000
• Maintenance costs € 14,000 per year.
• Waste related costs of € 5,000 per year
• The machine is going to be operated for the next 5 years
• Linear depreciation is applied. Accounting salvage value is zero after 5 years of operation. However, it is estimated that the potential market value of the new machine is 25% of the purchase price.
• Replacement requires additional investments of € 12,000 into net working capital, which is expected to be recovered when project ends.
• The company applies 10% cost of capital for this type of replacement projects
• Corporate tax rate is 40% on both profits and capital gains.

Find:

a) Incremental cash flows from replacing the machine (including investment, annual cash flow, and closing cash flow)

d) Based on the NPV, assess whether the replacement is economically viable

Kong Ltd is a home appliance manufacturer listed on the local stock exchange. The company has no debt but has 100 million shares with a current price $10 per share. The company would like to change its capital structure by borrowing $300 million and repurchasing shares. The restructure plan is announced to the market and shareholders expect the change in debt to be permanent

(i). Assume the market is perfect so all the assumptions of Modigliani and Miller (MM) theorey hold. Calculate the value of the firm and the value of equity after the proposed share repurchase.

(ii). Assume the market is imperfect and the only imperfections are corporate taxes and financial distress costs. Kong pays corporate taxes of 40%. If the share price of Kong Ltd increases to $10.6 immediately after the announcement of the capital restructure plan, what is the present value of financial distress costs Kong will incur as the result of the debt?

1. Capital budgeting

The company is going to analyse a new investment project, which has the following characteristics:

Unit price                                                                $5.00

Annual unit sales                                                   40,000

Variable cost per unit                                           $2.5

Investment into new machinery (t=0)              $400,000

Investment in working capital                           $50,000               (fully recovered at the end of project)

Project life                                                              6 years

Annual depreciation                                             $60,000

Market value of machinery (t=6)                       80,000

Tax rate                                                                    40 %                     (the same for profits and capital gains)

Required rate of return (WACC)                        10 %

Marketing research expense                              $16,000               (the research was done earlier this year)

Questions:

1. Find the project cash flows (incl. initial investment, operating cash flows each year and terminal cash flow)
2. Evaluate the project NPV
3. Should the company invest into such project? Explain.

1. Capital budgeting.

Põltsamaa Felix, an exclusive Estonian fruit wine producer, is considering the purchase of 10,000 French oak barrels at a cost of 900 eur each. The investment into barrels is considered a capital expense and would be depreciated straight line over 5 years.

After 4 years, the barrels will be useless for making fine wine, but they expect to be able to sell them for 3.5 million EUR to E & J Gallo, the world largest wine producer. The increase in the quality of its sweet apple line of wines due to the use of the new French oak barrels is expected to increase revenue by 7 million eur (but only) in years 3 and 4. The barrels would have no influence on COGS, SG&A or other operating expenses. The additional working capital investment is 10% of the additional sales revenues and is fully recovered when the project ends (in four years). Note that the investment into working capital is made just before the expected sales increase. The tax rate is 30% (profits are taxed), and the required return is 14%.

1. Construct the capital budget
2. Evaluate the project on the basis of NPV and MIRR.

How do we determine if cash flows are relevant to the capital budgeting decision?

What are sensitivity analysis, scenario analysis, break-even analysis, and simulation? Why are these analyses important, and how should they be used?

The margin requirement on the S&P 500 futures contract is 10%, and the stock index is currently 1,200. Each contract has a multiplier of $250.

a. How much margin must be put up for each contract sold?

Margin            $   

b. If the futures price falls by 2% to 1,176, what will happen to the margin account of an investor who holds one contract? (Input the amount as a positive value.)

Margin account (Click to select)increasesdecreases by $ .

c-1. What will be the investor's percentage return based on the amount put up as margin? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Percentage return             %

c-2. What would be the current cash balance in the margin account?

Cash balance            $

Problem 4-34 Growing Annuity

Your job pays you only once a year, for all the work you did over the previous 12 months. Today, December 31, you just received your salary of $59,000 and you plan to spend all of it. However, you want to start saving for retirement beginning next year. You have decided that one year from today you will begin depositing 10 percent of your annual salary in an account that will earn 9.9 percent per year. Your salary will increase at 2 percent per year throughout your career.

How much money will you have on the date of your retirement 35 years from today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Future value           $