BUS 330a: Corporate Finance I Fall 2012, American University in Bulgaria Prof.

Miroslav Mateev

HOMEWORK #4 Problem 1/Chapter 10 Your division is considering two investment projects, each of which requires an upfront expenditure of $15 million. You estimate that the investments will produce the following net cash flows: Year 1 2 3 Project A 5,000,000 10,000,000 20,000,000 Project B 20,000,000 10,000,000 6,000,000

a. What are the two projects net present values, assuming the cost of capital is 5%? 10%? 15%? b. What are the two projects IRRs at these same costs of capital?

Problem 2/ Chapter 10 Shao Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $30 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce net cash flows of $25 million per year. Shao plans to serve the route for only 10 years. Inflation in operating costs, airplane costs, and fares is expected to be zero, and the companys cost of capital is 12%. By how much would the value of the company increase if it accepted the better project (plane)? What is the equivalent annual annuity for each plane? Problem 3/ Chapter 10 Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this years capital budget. The projects are independent. The cash outlay for the truck is $17,100 and that for the pulley system is $22,430. The firms cost of capital is 14%. After-tax cash flows, including depreciation, are as follows: Year 1 2 3 4 Truck $5,100 $5,100 $5,100 $5,100 Pulley $7,500 $7,500 $7,500 $7,500

5 $5,100 $7,500 Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept reject decision for each. Note: do not use Excel function but rather compute the PV(CFO) and FV(CFI) to find MIRR and get full credits.

Problem 4/ Chapter 11 The Campbell Company is evaluating the proposed acquisition of a new milling machine. The machines base price is $108,000, and it would cost another $12,500 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs, mainly labor. Campbells marginal tax rate is 35%.

a. What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year-0 net cash flow?) b. What are the net operating cash flows in Years 1, 2, and 3? c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of working capital)? d. If the projects cost of capital is 12%, should the machine be purchased?

Problem 5/ Chapter 11 The Taylor Toy Corporation currently uses an injection-molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $2,100/6 = $350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life. Taylor is offered a replacement machine that has a cost of $8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class, so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The replacement machine would permit an output expansion, so sales would rise by $1,000 per year; even so, the new machines much greater efficiency would reduce operating expenses by $1,500 per year. The new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $500. Taylors marginal federalplus-state tax rate is 40%, and its WACC is 15%. Should it replace the old machine?