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some considerations should be taken into account when doing capital budgeting: incremental earnings, interest expenses, taxes, opportunity costs, externalities, sunk costs, cannibalization or erosion, depreciation, salvage value, and others. explain in detail what defines capital budgeting. Then explain how two of the considerations above affect capital budgeting.

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A;B

B;A

B;B

A;A

What is the distance between the Security Market Line and the expected rate of an investment indicate?

For each example, calculate the present value, or net present value, of the future amount(s) to support your answer and show your work using either factors (pp. 219 & 221 in the text), an Excel spreadsheet with the Excel PV or NPV functions or the equations, such as PV = FV / (1+Interest Rate)^Time.

1. Suppose you have a project where you will invest $20,000 today and receive one payment $26,200 exactly 5 years in the future. If your opportunity cost rate (the return you could get on other investments of similar risk) were 5.0% per year, would you approve this project strictly from a financial standpoint, meaning is the PV of the future cash flow greater than the $20,000 initial investment? Explain why.
2. Change the example so that, rather than the $26,200 in in 5 years, you receive $4,600 at the end of each of the next 5 years. You still invest $20,000 at the beginning. What advantage does this offer have, relative to the first one? Would you approve this one? Explain why.
3. One more example. How about if you invest the same $20,000 but this time the offer is to pay you $1,900 per year to you (and your heirs) forever. Would you make that investment?
4. Based on the current unsettled economic conditions, your boss is not sure about the 5% opportunity cost. She wants you to also look at the possibility of a 3% rate and a 7% rate. What effect does changing the rates have on the acceptability of the projects?
5. From these examples, sum up what you have learned about the time value of money. Can you lay out some general rules about how changes in the inputs affect the output?

2.) Mutually exclusive projects may be ranked differently when higher or lower discount rates are used.

a. True

b. False

13.) The option to abandon a project before the end of its forecasted life may increase its NPV.

a. True

b. False

18.) Porter Climate Control is evaluating a proposal to move some manufacturing operations from an obsolescent plant in Illinois to a new facility in Mexico. The new facility will cost $58 million to open. and is expected to result in savings of $16 million per year for the first five years. At the end of 5 years, Porter will decide either to close the plant in Mexico or to keep it indefinitely. If Porter closes the plant, the building and equipment can be sold for $20,000,000. If the plant is kept, assume that the $16 million turns into a perpetuity. There is a 30% chance the plant will be closed and a 70% chance it will be kept. Compute the expected NPV of the project. Use a discount rate of 12%.

a. $75.32 million

b. ($30.32 million)

c. $56.04 million

d. $114.04 million

Porter Climate Control is evaluating a proposal to move some manufacturing operations from an obsolescent plant in Illinois to a new facility in Mexico. The new facility will cost $58 million to open. and is expected to result in savings of $16 million per year for the first five years. At the end of 5 years, Porter will decide either to close the plant in Mexico or to keep it indefinitely. If Porter closes the plant, the building and equipment can be sold for $20,000,000. If the plant is kept, assume that the $16 million turns into a perpetuity. There is a 30% chance the plant will be closed and a 70% chance it will be kept. Compute the expected NPV of the project. Use a discount rate of 12%.

a $75.32 million

b ($30.32 million)

c $56.04 million

d $114.04 million

Martin enterprises needs someone to supply it with 125,000 cartons of machine screw per year to support its manufacturing needs over the next five years, and you've decided to bid on the contract. it will cost you 910,000 to install the equipment necessary to start production , It will you 910,000 to install the equpment neccessary to start production , you'll depreciate this cost straght-line to zero over the projects life. You estimate that, in five years, this equipment can be salvaged for 85,00. Your fixed production costs will be 485,000 per year, and your variable producyion costs should be $17.35 per carton. You also need an initial investment in net working capital of $90,000. If your tax rate is 21 percent and you require a return of 12 percent on your investment, what bid price should you submit?

Imagine that you are holding 5,600 shares of stock, currently selling at $55 per share. You are ready to sell the shares but would prefer to put off the sale until next year due to tax reasons. If you continue to hold the shares until January, however, you face the risk that the stock will drop in value before year-end. You decide to use a collar to limit downside risk without laying out a good deal of additional funds. January call options with a strike price of $60 are selling at $3, and January puts with a strike price of $50 are selling at $4. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $45, $55, $65? What will the value of your portfolio be if you simply continued to hold the shares?

Calculate the expected return on a portfolio of 55 percent Roll and 45 percent Ross by filling in the following table: (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

A project that provides annual cash flows of $17673 for eight years costs $80339 today. What is the NPV for the project if the required return is 19 percent? (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places. (e.g., 32.16))

Sunrise, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $70,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios. 1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. 2. Calculate the percentage changes in EPS when the economy expands or enters a recession. 3.Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. 4. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession

You buy an eight-year bond that has a 5.50% current yield and a 5.50% coupon (paid annually). In one year, promised yields to maturity have risen to 6.50%. What is your holding-period return?

Problem 11-03

An investor with a required return of 14 percent for very risky investments in common stock has analyzed three firms and must decide which, if any, to purchase. The information is as follows:

Stock A: $  

Stock B: $  

Stock C: $  

%

Stock A: $  

Stock B: $  

Stock C: $  

1. • What is the maximum price that the investor should pay for each stock based on the dividend-growth model? Round your answers to the nearest cent.
   • If the investor does buy stock A, what is the implied percentage return? Round your answer to two decimal places.
   • If the appropriate P/E ratio is 11, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.
2. If the appropriate P/E ratio is 5, what is the maximum price the investor should pay for each stock? Round your answers to the nearest cent.

   Stock A: $  

   Stock B: $  

   Stock C: $