Kansas Corp, an American company, has a payment of 5 million euros due to Tuscany Corp. one year from today. At the prevailing spot rate of 0.90 euro/dollar, this would cost Kansas $5,555,556, but Kansas faces the risk that the euro/dollar rate will fall in the coming year, so that it will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy 5 million euros forward today at a one-year forward rate of 0.80 euro/dollar. Strategy 2 is to pay a premium of $100,000 for a one-year call option on 5 million euros at an exchange rate of 0.88 euro/dollar. a. Suppose that in one year the spot exchange rate is 0.85 euro/dollar. What would be Kansas' net dollar cost for the payable under each strategy? b. Suppose that in one year the spot exchange rate is 0.95 euro/dollar. What would be Kansas' net dollar cost for the payable under each strategy? c. Which hedging strategy would you recommend to Kansas Corp? Why?

Determine why it is sometimes misleading to compare a company’s financial ratios with those of other firms that operate within the same industry. Support your response with one (1) example from your research.

REPLACEMENT ANALYSIS

The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $575,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $250,000. The old machine is being depreciated by $115,000 per year, using the straight-line method.

The new machine has a purchase price of $1,125,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $155,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $250,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.

1. What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
   $
   
2. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.

   Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
   1	$	$	$
   2
   3
   4
   5

3. What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.

   Year 1	Year 2	Year 3	Year 4	Year 5
   $	$	$	$	$

4. Should the firm purchase the new machine?
   -Select-YesNoItem 22
   
   Support your answer. The input in the box below will not be graded, but may be reviewed and considered by your instructor.
   
5. In general, how would each of the following factors affect the investment decision, and how should each be treated?
   1. The expected life of the existing machine decreases.

   The input in the box below will not be graded, but may be reviewed and considered by your instructor.

   2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year.

   The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Turn to the Right Drilling Co. (“TTR Drilling”) operates an aging fleet of offshore drilling rigs that are contracted to major integrated oil companies for exploration and production. Since the recent Deepwater Horizon disaster in the Gulf of Mexico, the majors have shown a strong preference for the safer, more technologically-advanced newbuild rigs and are willing to lease these rigs at higher rates than the older ones. Consequently, TTR Drilling is considering replacing their older rigs to take advantage of the higher potential dayrates for their contracts over the next five years. TTR’s current fleet produces annual revenues of $35 M per rig with cash costs of $16 M per rig. The older rigs also currently have $5 M tied up in NWC per rig. The CFO of the company has estimated annual revenues for newbuild rigs at $185 M per rig with cash costs of $30 M per rig. The new rigs would require $15 M in NWC each. The purchase price of a new rig is $750 M. They expect to depreciate this on a straight-line basis to zero over the next five years. However, the company estimates that a new rig could be sold for $400 M at the end of the project. If they purchased a new rig today, they could sell an old one on the open market for $30 M. The old rigs are currently carried on the books at $35 M each and are being depreciated on a straight-line basis by $5 M per year. If they decided to stick with the old rigs, they expect them to have a market value of only $15 M in five years. Assume that TTR Drilling faces a 40% corporate tax rate and an 19% cost of capital. What is the NPV of the decision (in $M per rig) to replace the old vessels with the new ones? (Hint: There is a very similar HW problem in your text.)

. Assume the following information:

What is your percentage return from covered interest arbitrage with $550,000 for one year?

1. You observed the bid rate of a New Zealand dollar is $.6723 while the ask rate is $.6812 at Bank X. The bid rate of the New Zealand dollar is $.6712 while the ask rate is $.6701 at Bank Y. What would be your dollar amount profit if you use $1,000,000 to execute locational arbitrage?

Suppose managers of a firm know that the company is approaching financial distress. Should the managers borrow from creditors and issue a large one-time dividend to shareholders? How might creditors control this potential transfer of wealth?

Dunder-Mifflin is considering opening a new branch in Columbia with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project.

At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. What is the NPV of this project if the firm requires a 10.80 percent rate of return? Enter the dollar amount as an integer value (ex. -$5,000.45 as -5000 or +$3,450.70 as 3451).

An investor has a bearish view of the stock, which he would like to take advantage of by constructing an option ‘spread’ strategy. Your goal is to maximize the initial cash inflow using this strategy. Suppose there exists the following options on the same underlying share of the stock. The share is currently trading in the market at $40.

1. Which options would you use for your spread strategy? Explain your answer.
2. Construct a payoff table for your option strategy. Show the payoff for individual options you use and the total payoff of the spread.
3. Draw a payoff diagram for your strategy, show the maximum and minimum level of payoff and strike price(s).

Bombardier, after spending $250,000 on a feasibility study, has determined that its customers will be willing to pay more money for the C Series model if Bombardier invests in a manufacturing technology upgrade that can enhance the safety of the engine. Bombardier realizes that the delays in the C Series program are likely costing them potential sales of the C Series jets. The feasibility study allowed management to better understand the implementation costs of the new technology as well as the potential payoff. Thus, they see the opportunity to make a short-term investment in the engine technology that will affect the next eight years of production in order to improve their overall offering to their customers.

Because the C Series production facilities are already covered in original cost estimates, no additional costs for production facilities are required. However, the required new machinery will cost $2,000,000 and will be subject to capital cost allowance depreciation (Asset Class 8, 20% CCA rate). When the C Series program expires after year eight, Bombardier executives figure there will be $324,578 in salvage on the equipment. Sales across the eight years of the C Series program are projected to be 18 units, 22 units, 29 units, 43 units, 54 units, 34 units, 36 units, and 39 units.

Bombardier expects that the price to their customers will start at an additional $120,000 with three per cent increases per year, as they wish to keep their prices competitive. Material costs of production are expected to be $68,000 per unit, growing at four per cent a year. Fixed costs per annum will amount to $680,000. The corporate tax rate Bombardier is subject to is 26.7 per cent, as of end of fiscal 2018.

Finally, Bombardier requires a maintained investment in working capital of $375,000 at the beginning of the project. This will stay at 15 per cent of sales at the end of each year, and reduces to 0 by the project's end; therefore, the investment in working capital is fully recovered by the project's end. As the company will be purchasing raw materials prior to production and sales delivery, they must create an investment in inventory as well as maintaining some cash as a buffer against unforeseen expenses. If the firm has negative taxable income from the project in a given year, please assume that the firm has positive income from other projects, so that the loss can be written off (as a tax benefit) against this other project income in the same year.

Questions

2.     What is the Net Present Value of the project if the required rate of return (Weighted Average Cost of Capital) is equal to 3.80 per cent?

3.    By how much would the Net Present Value of the project change if unit sales were 25 per cent less than expected (round down toward zero the number of units)?

Use DerivaGem to calculate the value of an American put option on a non-dividend-paying stock when the stock price is USD 30, the strike price is USD 32, the risk-free rate is 5% p.a. continuously compounded, the volatility is 30% p.a. and the time to maturity is 1.5 years. (Choose ‘Binomial American’ for the option type and 50 time steps.) (See textbook Chapter 13 for supporting theory and materials)

1. Calculate the option’s intrinsic value. Calculate the option’s time value.
2. What would a time value of zero indicate? What is the value of an option with zero time value?
3. Using a trial and error approach, calculate how low the stock price would have to be for the time value of the option to be zero. (use 50 time steps)

IT Software Project

As a senior analyst for the company you have been asked to evaluate a new IT software project. The company has just paid a consulting firm $50,000 for a test marketing analysis. After looking at the project plan, you anticipate that the project will need to acquire computer hardware for a cost of $400,000. The Australian Taxation Office rules allow an effective life for the computer hardware of five years. The equipment can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after the five years.

Your company does not have any available space where the project can be located for five years and you anticipate a new office will cost $80,000 to rent for the first year. You expect that the project will need to hire 3 new software specialists at $50,000 (each specialist) in the first year for the full five years to work on the software.

The project will use a van currently owned by the company and although the van is not currently being used by the company, it can be rented out for $5,000 per year for five years (inclusive inflation). The book value of the van is $20,000. The van is being depreciated straight-line (with five years remaining for depreciation) and is expected to be worthless after the five years.

Expected annual marketing and selling costs will be incurred during the life of the project (5 years), with the first year expecting to be $200,000. The produced software is expected to sell at $100 per unit while the cost to produce each unit is $40. You expect that 10,000 units will be sold in the first year and the number of units sold will increase by 20% a year for the remaining four years. The project will need working capital of $50 000 to commence the business (in year 0) and the investment in working capital is to be completely recovered by the end of the project’s life (in year 5). The company tax rate is 30%, and the discount rate is 10%.

Based on the information presented above, answer the following questions (1) – (3).

1. In evaluating the new IT software project, are the cost of $50,000 spent on marketing analysis and the use of van relevant for capital budgeting decision? Explain your answer(s).

2. Calculate the incremental free cash flow during the project’s life (at the end of Years 1 through 5). Show workings.

3. Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s).

1. Olsen Outfitters Inc. believes that its optimal capital structure consists of 70% common equity and 30% debt, and its tax rate is 40%. Olsen must raise additional capital to fund its upcoming expansion. The firm will have $4 million of retained earnings with a cost of r_s = 12%. New common stock in an amount up to $9 million would have a cost of r_e = 14%. Furthermore, Olsen can raise up to $3 million of debt at an interest rate of r_d = 10% and an additional $3 million of debt at r_d = 12%. The CFO estimates that a proposed expansion would require an investment of $5.8 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.

2.

The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow 8% per year. Callahan's common stock currently sells for $28.25 per share; its last dividend was $2.00; and it will pay a $2.16 dividend at the end of the current year.

1. Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places. Do not round your intermediate calculations.
   %
2. 
   
3. If the firm's beta is 1.70, the risk-free rate is 7%, and the average return on the market is 12%, what will be the firm's cost of common equity using the CAPM approach? Round your answer to two decimal places.
   %
4. 
   
5. If the firm's bonds earn a return of 11%, based on the bond-yield-plus-risk-premium approach, what will be r_s? Use the midpoint of the risk premium range discussed in Section 10-5 in your calculations. Round your answer to two decimal places.
   %
6. 
   
7. If you have equal confidence in the inputs used for the three approaches, what is your estimate of Callahan's cost of common equity? Round your answer to two decimal places. Do not round your intermediate calculations.

Neile looked at his mechanic and sighed. The mechanic had just pronounced a death sentence on his road-weary car. The car had served him well---at a cost of $500 it had lasted through four years of college with minimal repairs. Now, he desperately needs wheels. He has just graduated, and has a good job at a decent starting salary. He hopes to purchase his first new car. The car dealer seems very optimistic about his ability to afford the car payments, another first for him.

The car Neile is considering is $35,000. The dealer has given him three payment options:

1. Zero percent financing. Make a $4000 down payment from his savings and finance the remainder with a 0% APR loan for 48 months. Neile has more than enough cash for the down payment, thanks to generous graduation gifs.

2. Rebate with no money down. Receive a $4000 rebate, which he would use for the down payment (and leave his savings intact), and finance the rest with a standard 48-month loan, with an 8% APR. He likes this option, as he could think of many other uses for the $4000.

3. Pay cash. Get the $4000 rebate and pay the rest with cash. While Neile doesn’t have $35,000, he wants to evaluate this option. His parents always paid cash when they bought a family car; Neile wonders if this really was a good idea.

Q.1: What are the cash flows associated with each of Neile’s three care financing options?