Question

6)	Company is considering the purchase of a piece of equipment in '12.
	The projected cost of the equipment is					50,000
	The equipment will be depreciated via the MACRS - 5 year life
	This equipment is expected to generate the following economics:
		Revenue for first year will be					45,700
		Revenue will increase by					1.0%	per year thereafter
		Expenses for first year will be					29,700
		Expenses will decrease by					1.0%	per year thereafter
	Company's Capital Structure is as follows:
		Bonds			50,000
		Preferred Stock			75,000
		Common Stock			0
	Company will finance projects based on their historic approach.
	Relevant financing information is as follows:
	Bond Market rate in year - (2012)				5%
	Company Tax Rate				35%
	Preferred Stock Information
	Sales Price				40.00
	Dividend				2.35
	Flotation Cost (Percentage)				4.0%
	Common Stock Information
	Sales Price				50.00
	Flotation Cost (Percentage)				2%
	Dividend History
		Year	Dividend
		2009	0.98
		2010	1.04
		2011	1.12
	Company will evaluate the first four years of cash flows only
	1) Based on Payback criteria of 3 years - should the asset be purchased
	2) Based on NPV - Hurdle rate of Cost of Capital plus 2% - should the asset be purchased
	3) At what rate is the company indifferent
	4) If the company financed solely with P/S, should the asset be purchased

Answer 1

1) Yes, the assets should be purchased

2) Yes, based on hurdle rate of 2%, the assets shlould be purchased

3) At 24% the company is indifferent

4) Yes, is the company is financed only with P/s, the asset should be purchased.

Note: Though Dividend declared by Company is given, the Capital structure currently has no Share Capital

Year	0	1	2	3	4
Initial Investment	(50,000)
Revenue		45,700	50,270	55,297	60,827
Expenses		29,700	26,730	24,057	21,651
Total incremental income		16,000	23,540	31,240	39,175
After Taxes Income (35%)		10,400	15,301	20,306	25,464
Depreciation Tax Shield		6,125	4,550	2,730	1,927
Total Cash Inflow/ ( Outflow)	(50,000)	16,525	19,851	23,036	27,391
Present Value Factor 2%	1	0.9804	0.9612	0.9423	0.9238
Present Worth	(50,000)	16,201	19,080	21,707	25,305	32,293
IRR	24%
Pay Back Period	2.59
Present value factor 6% (only P/S)	1.0000	0.9434	0.8900	0.8396	0.7921
Present Worth	(50,000)	15,590	17,667	19,341	21,696	24,294
Calculation of Costs of Debt = 5*65% =3.25%
Costs of P/S = 2.35/(40*96%)= 6%