NEW PROJECT ANALYSIS

You must evaluate a proposal to buy a new milling machine. The base price is $153,000, and shipping and installation costs would add another $7,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $68,850. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $3,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $35,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

1. How should the $5,000 spent last year be handled?
   1. Last year's expenditure is considered as an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
   2. Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
   3. The cost of research is an incremental cash flow and should be included in the analysis.
   4. Only the tax effect of the research expenses should be included in the analysis.
   5. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.
   
   -Select-IIIIIIIVVItem 1

2. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
   $

3. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent. Do not round your intermediate calculations.

   Year 1 $

   Year 2 $

   Year 3 $

4. Should the machine be purchased?
   -Select-YesNo

Read the two articles in the links below about affinity credit cards and schools. After reading these, do you think universities should enter into agreements to offer affinity credit cards to students? Why or why not? Discuss the ethics of such offerings.

http://www.insidehighered.com/news/2010/02/19/credit

https://www.bloomberg.com/news/articles/2007-09-06/the-dirty-secret-of-campus-credit-cardsbusinessweek-business-news-stock-market-and-financial-advice

Also, I challenge each of you to find websites that calculate or explain NPV. What did you find? Anything with light humor? (Subject: Finance)

A firm is considering replacing the existing industrial air conditioning unit. They will pick one of two units. The first, the AC360, costs $26,388.00 to install, $5,005.00 to operate per year for 7 years at which time it will be sold for $7,074.00. The second, RayCool 8, costs $41,921.00 to install, $2,139.00 to operate per year for 5 years at which time it will be sold for $9,087.00. The firm’s cost of capital is 6.16%. What is the equivalent annual cost of the RayCool8? Assume that there are no taxes.

A firm is considering replacing the existing industrial air conditioning unit. They will pick one of two units. The first, the AC360, costs $26,192.00 to install, $5,133.00 to operate per year for 7 years at which time it will be sold for $7,113.00. The second, RayCool 8, costs $41,856.00 to install, $2,172.00 to operate per year for 5 years at which time it will be sold for $9,076.00. The firm’s cost of capital is 6.09%. What is the equivalent annual cost of the AC360? Assume that there are no taxes.

Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $25.00 million. The plant and equipment will be depreciated over 10 years to a book value of $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.02 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.52 million per year and cost $1.77 million per year over the 10-year life of the project. Marketing estimates 14.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 26.00%. The WACC is 10.00%. Find the IRR (internal rate of return).

Won’t Quit has 1 million shares of common stock outstanding with

a market price of $12 per share. The firm's outstanding bonds have

ten years to maturity, a face (book) value of $5 million, a coupon

rate of 10%, and currently sell for $985 per $1000 of face value. The

risk

-

free rate is 7%, and the expected return on the S&P 500 is 14%.

The firm pays taxes at the rate of 40%, and their stock has an

estimated beta of 1.2.

What’s your estimate for Won’t Quit’s WACC?

Review - Growing Annuity valuation

An investment offers $1000 to be received 9 years from today. After that payment, there will be nine more annual payments growing at a rate of 7% per year (for a total of 10 payments). If the relevant discount rate is 11% per year, the Present Value today of the entire investment is $_____.

Find the duration of a 5% coupon bond making annual coupon payments if it has three years until maturity and a yield to maturity of 6.3%. What is the duration if the yield to maturity is 10.3%? (Do not round intermediate calculations. Round your answers to 4 decimal places.)

Minion, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $30,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $75,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Ignore taxes for this problem.

Brown Industries has a debt-equity ratio of 1.3. Its WACC is 8 percent, and its cost of debt is 5 percent. There is no corporate tax.

New Stock Issue

Bynum and Crumpton, a small jewelry manufacturer, has been successful and has enjoyed a positive growth trend. Now B&C is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price for the stock. The company and its investment banks believe that the proper procedure is to conduct a valuation and select several similar firms with publicly traded common stock and to make relevant comparisons.
Several jewelry manufacturers are reasonably similar to B&C with respect to product mix, asset composition, and debt/equity proportions. Of these companies, Abercrombe Jewelers and Gunter Fashions are most similar. When analyzing the following data, assume that the most recent year has been reasonably "normal" in the sense that it was neither especially good nor especially bad in terms of sales, earnings, and free cash flows. Abercrombe is listed on the AMEX and Gunter on the NYSE, while B&C will be traded in the NASDAQ market.

1. B&C is a closely held corporation with only 500,000 shares outstanding. Free cash flows have been low and in some years negative due to B&C's recent high sales growth rates, but as its expansion phase comes to an end, B&C's free cash flows should increase. B&C anticipates the following free cash flows over the next 5 years:

   Year	1	2	3	4	5
   FCF	$1,000,000	$1,050,000	$1,208,000	$1,329,000	$1,462,000

   After Year 5, free cash flow growth will be stable at 7% per year. Currently, B&C has no nonoperating assets, and its WACC is 12%. Using the free cash flow valuation model, estimate the (1) horizon value, (2) intrinsic value of operations, (3) intrinsic value of equity, and (4) intrinsic per share price. Do not round intermediate calculations. Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answers for the value of equity to the nearest dollar and for the value of equity per share to the nearest cent.

   (1) Horizon value	$
   (2) Intrinsic value of operations	$
   (3) Intrinsic value of equity	$
   (4) Intrinsic per share price	$

2. Calculate debt to total assets, P/E, market to book, P/FCF, and ROE for Abercrombe, Gunter, and B&C. For calculations that require a price for B&C, use the per share price you obtained with the corporate valuation model in Part a. Do not round intermediate calculations. Round your answers to two decimal places.

   	Abercrombe		Gunter		B&C
   D/A		%		%		%
   P/E
   Market/Book
   ROE		%		%		%
   P/FCF

3. Using Abercrombe's and Gunter's P/E, Market/Book, and Price/FCF ratios, calculate the range of prices for B&C's stock that would be consistent with these ratios. For example, if you multiply B&C's earnings per share by Abercrombe's P/E ratio you get a price. What range of prices do you get? Do not round intermediate calculations. Round your answers to the nearest cent.

   The range of prices:
   from $   to $  

   How does this compare with the price you get using the corporate valuation model?

   The price obtained with the corporate valuation model is -Select-withinout ofItem 22 this range of prices.

Your division is considering two projects with the following cash flows (in millions):

Project A: Cash Flow 0= -$17, CF1= $8, CF2= $8, CF3= $3

Project B: Cash Flow 0= -$26, CF1= $13, CF2= $10, CF3= $9

a) What are the projects' NPVs assuming the WACC is 5%? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to two decimal places.

What are the projects' NPVs assuming the WACC is 10%? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to two decimal places.

What are the projects' NPVs assuming the WACC is 15%? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative values, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to two decimal places.

b) What are the projects' IRRs assuming the WACC is 5%? Do not round intermediate calculations. Round your answer to two decimal places.

What are the projects' IRRs assuming the WACC is 10%? Do not round intermediate calculations. Round your answer to two decimal places.

What are the projects' IRRs assuming the WACC is 15%? Do not round intermediate calculations. Round your answer to two decimal places.

c) If the WACC was 5% and A and B were mutually exclusive, which project would you choose? (Hint: The crossover rate is 20.19%.)

If the WACC was 10% and A and B were mutually exclusive, which project would you choose? (Hint: The crossover rate is 20.19%.)

If the WACC was 15% and A and B were mutually exclusive, which project would you choose? (Hint: The crossover rate is 20.19%.)