Question

1. Answer both (unrelated) parts a and b.

a.) Nipper Corp., which sells glow-in-the-dark pacifiers to anxious parents, is planned to expand its capacity. Nipper is considering buying a new piece of equipment that would cut the radioactivity in each pacifier. Onealternative would cost them $85,000 for new machinery and provide them with cash flows of $30,000 per year for the next four years. The other would cost $192,000 but would result in cash flows of $58,000 a year over the same four year period. Assuming that the cost of capital Nipper faces is 9.0%, evaluate the NPV and IRR of these projects and determine which one (i.e. mutually exclusive) you would choose. Explain your reasoning. Show all work!  

b.) Assume you are the financial manager with a hard capital rationing constraint of $20 million. You may invest in the following independent projects. Investment and cash flow figures are in millions.

	Project	Investment	Net Present Value
	A	5	3
	B	6	1
	C	11	3
	D	5	2
	E	4	1

Using the Profitability Index, which projects should you choose given the budget constraint? Which would you choose if there was no capital rationing? Show all work.

2. Construct a Market Value Balance Sheet  for Trump-Toppers, Inc. (TT), a manufacturer of custom-made hairpieces, based on the following data (FYI: There are no other liabilities or equity issues other than those mentioned below.): (answer parts a through c)

a.) The company has issued $1,000 bonds that will mature in 5 years with a total face value of $45,000,000. The coupon rate on the bond is 7.0%, but the market interest rate on similar bonds is now 4.5%. What is the price of one bond and market value of the entire bond issue?

b.) The company also has 25,000,000 shares of common stock outstanding. The company’searnings are expected to be $15 per share and it plans to pay out 40% of its earnings to its shareholders. With the growing popularity of fashionable cover-ups providing new expansion opportunities, the company expects that it can realize an estimated return on equity (ROE) of 22%, and, given the riskiness of the stock, the required rate of return is 20%. Calculate the price per share and the market value of the total equity position.

c.) The book value of assets in place (plant and equipment) is $640,000,000. Indicate the value of investment opportunities.

3. Answer parts a through e regarding the following investment project.

Ms. Phy Nance, a project analyst at DROF Motor Co., would like her project included in next year’s capital budget. According to her report, the new equipment would cost $185,217 and its projected cash flows would be as follows:

Year 1​​40,000​​

Year 2​​50,000​​

Year 3​​53,000​​

Year 4​​53,000​​

Year 5​​70,000​​

The cost of capital is 12%

a) What is the NPV calculated by the analyst? If her numbers are correct should you accept the project?

b) Assume that the analyst included shipping and set-up costs of $5,217 in her estimation of the cost of the initial investment. Is this procedure correct? Why?

c) Assume that no consideration was given to the fact that the floor space used for this project could have been rented each year for $9,000 per year. How would this affect the calculation?

d) Included in her analysis, Ms. Nance calculated that lighting, heating and air conditioning cost the company $7,500 per year and that the new equipment occupies 40% of the total floor space --so she deducted $3,000 per year from the cash flows to reflect overhead costs for the new equipment. Is this deduction correct or should it be reversed?

e) Given your answers to b, c, and d, what is your calculation of Net Present Value for this project and would you include it in next year’s capital budget?

Answer 1

Note 1: As per the rules answering only question 1
Information Given
Year	Cash Flow(A)	Cash flow(B)
0	-85000	-192000
1	30000	58000
2	30000	58000
3	30000	58000
4	30000	58000

Part a)

NPV = -CFO+ CF1/(1+R)1 + CF2/(1+R)2 + CF3(1+R)3 + CF4/(1+R)4

CF= cash flow

R = cost of capital

(A) -85000+30000/(1+9%)1+30000/(1+9%)2+30000/(1+9%)3+30000/(1+9%)4

= 12191.60

(B) -192000+58000/(1+9%)1+58000/(1+9%)2+58000/(1+9%)3+58000/(1+9%)4

= -4096.25

IRR = -CFO+ CF1/(1+IRR)1 + CF2/(1+IRR)2 + CF3(1+IRR)3 + CF4/(1+IRR)4

(A)

= -85000+30000/(1+IRR)1+30000/(1+IRR)2+30000/(1+IRR)3+30000/(1+IRR)4

= 15.38%

(B)

= -192000+58000/(1+IRR)1+58000/(1+IRR)2+58000/(1+IRR)3+58000/(1+IRR)4

= 8.02%

since NPV and IRR of project A is more it should be choosen

Part b)

Profitability Index = Present value of cash inflow / Cash outflow

A)  3 / 5 = 0.6

B) 1/6 = 0.17

C) 3/11= 0.27

D) 2/5= 0.4

E) 1/4= 0.25