A corporate bond with a coupon rate of 7.2 percent has 18 years left to maturity. It has had a credit rating of BBB and a yield to maturity of 7.9 percent. The firm has recently gotten into some trouble and the rating agency is downgrading the bonds to BB. The new appropriate discount rate will be 9.2 percent.

What will be the change in the bond’s price in dollars?

What will be the change in the percentage?

2. Net present value (NPV)

The capital budgeting process is comprehensive and is based on certain assumptions, models, and benchmarks. This process often begins with a project analysis. Generally, the first step in a capital budgeting project analysis—which occurs before any evaluation method is applied—involves estimating the project’s expected cash flows   .

Evaluating cash flows with the NPV method

The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions.

Consider this case:

Suppose Fuzzy Button Clothing Company is evaluating a proposed capital budgeting project (project Beta) that will require an initial investment of $2,750,000. The project is expected to generate the following net cash flows:

Fuzzy Button Clothing Company’s weighted average cost of capital is 8%, and project Beta has the same risk as the firm’s average project. Based on the cash flows, what is project Beta’s NPV? (Note: Do not round your intermediate calculations.)

a. -$4,059,142

b. -$1,309,142

c. $1,440,858

d. -$859,142

Making the accept or reject decision

Fuzzy Button Clothing Company’s decision to accept or reject project Beta is independent of its decisions on other projects. If the firm follows the NPV method, it should   project Beta.

Suppose your boss has asked you to analyze two mutually exclusive projects—project A and project B. Both projects require the same investment amount, and the sum of cash inflows of Project A is larger than the sum of cash inflows of project B. A coworker told you that you don’t need to do an NPV analysis of the projects because you already know that project A will have a larger NPV than project B. Do you agree with your coworker’s statement?

No, the NPV calculation will take into account not only the projects’ cash inflows but also the timing of cash inflows and outflows. Consequently, project B could have a larger NPV than project A, even though project A has larger cash inflows.

No, the NPV calculation is based on percentage returns, so the size of a project’s cash flows does not affect a project’s NPV.

Yes, project A will always have the largest NPV, because its cash inflows are greater than project B’s cash inflows.

Weismann Co. issued 14-year bonds a year ago at a coupon rate of 10 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 9 percent, what is the current bond price?

We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $380 million to purchase equipment, and $30 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of the fixed assets is 10.5% of the purchase price (including the shipping & installation fee). The number of units of the new product expected to be sold in the first year is 1,500,000 and the expected annual growth rate is 5.5%. The sales price is $255 per unit and the variable cost is $190 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.2%. The required net operating working capital (NOWC) is 9.5% of sales. Use the corporate tax rate obtained in Step (4) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Note: you may revise the partial model in the file Ch11 P18 Build a Model.xls on the website of the textbook (also posted in this final project learning module in Blackboard) for capital budgeting analysis, but you are NOT required to strictly follow the partial model. Actually, you are encouraged to build a better model by yourself. - Compute the depreciation basis and annual depreciation of the new project. (You can refer to Table 11A-2 MACRS allowances on pp.496 in the textbook) - Estimate annual cash flows for 8 years. - Draw a time line of the cash flows. WACC = 7.20% Corporate Tax Rate = 18.30%

15. Imagine you are investing for one year and are considering three different bonds, each with a $1000 face value: A one-year treasury bill. A two-year zero coupon Treasury. A ten-year zero coupon Treasury. Today, each bond has a 4% yield to maturity. For each of the following scenarios, compute the return you'd get on each of the three bonds under consideration. A) Yields increase to 5%. B) Yields fall to 2%. Show all calculations.

17. You have a 2% bond paying annual coupons, 3 years until maturity with $1000 face value. Yield to maturity is 2.5%. What is the duration of the bond? Show all calculations.

18. Suppose there is another bond which pays annual coupons of 5% and has 3 years to maturity with a $1000 face value. Yield to maturity is 2.5%. Is the duration of this bond higher or lower than the bond in question 17?

You are planning to make monthly deposits of $475 into a retirement account with an APR of 10 percent interest compounded monthly. If your first deposit will be made one month from now, how large will your retirement account be just after three months. Round your answer to the nearest dollar.

Then using the same numbers calculate what it will be after just 2 months

The Bruin's Den Outdoor Gear is considering a new 7-year project to produce a new tent line. The equipment necessary would cost $1.59 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 10 percent of its initial cost. The company believes that it can sell 26,000 tents per year at a price of $69 and variable costs of $29 per tent. The fixed costs will be $445,000 per year. The project will require an initial investment in net working capital of $213,000 that will be recovered at the end of the project. The required rate of return is 11.2 percent and the tax rate is 34 percent. What is the NPV?

Multiple Choice

• $816,841

• $1,186,611

• $660,072

• $510,939

• $548,380

Renegade Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3.12 million and will last for six years. Variable costs are 31% of sales, and fixed costs are $2,006,820 per year. Machine B costs $4.92 million and will last for nine years. Variable costs for this machine are 24% of sales and fixed costs are $1,342,459 per year. The sales for each machine will be $9.4 million per year. The required return is 10 %, and the tax rate is 38%. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Calculate the EAC for machine A. (Round answer to 2 decimal places. Do not round intermediate calculations)

A large retailer such as Walmart possesses power over smaller suppliers. In theory, Walmart could force these suppliers to sell on payment terms that were well beyond a typical industry norm.

1. How would this impact Walmart’s cash cycle?
2. How would this impact the suppliers’ cycle?
3. Are there any ethical issues involved in such a practice?

Amazing Manufacturing, Inc., has been considering the purchase of a new manufacturing facility for $520,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value at that time. Operating revenues from the facility are expected to be $400,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $245,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 23 percent. Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16)

Harry’s Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a bank loan to do this. Mr. Wilson, the banker, will finance construction if the firm can present an acceptable three-month financial plan for January through March. The following are actual and forecast sales figures:

Of the firm’s sales, 50 percent are for cash and the remaining 50 percent are on credit. Of credit sales, 35 percent are paid in the month after sale and 65 percent are paid in the second month after the sale. Materials cost 30 percent of sales and are purchased and received each month in an amount sufficient to cover the following month’s expected sales. Materials are paid for in the month after they are received. Labor expense is 40 percent of sales and is paid for in the month of sales. Selling and administrative expense is 15 percent of sales and is paid in the month of sales. Overhead expense is $30,500 in cash per month.

Depreciation expense is $10,500 per month. Taxes of $8,500 will be paid in January, and dividends of $4,500 will be paid in March. Cash at the beginning of January is $90,000, and the minimum desired cash balance is $85,000.

Assume the market price of a 6​-year bond for Margaret Inc. is ​$775​, and it has a par value of $ 1,000. The bond has an annual interest rate of 7​% that is paid semiannually. What is the yield to maturity of the​ bond?

The yield to maturity of the bond is