Problem set 2

Problem Set 2

Complete the following problem sets from the “Problems” section in Chapters 9-11 and 23 of Financial Management: Theory and Practice.

1. Chapter 9: 9-2, 9-5, 9-6, and 9-8
2. Chapter 10: 10-1, 10-2, 10-3, 10-4, 10-5, 10-6, and 10-8
3. Chapter 11: 11-1, 11-2, 11-3, 11-4, and 11-6
4. Chapter 12: 23-1 and 23-2

Chapter 9

9-2. LLIncorporated’scurrentlyoutstanding11%couponbondshaveayieldtomaturityof8%.LLbelievesitcouldissuenewbondsatparthatwouldprovideasimilaryieldtomaturity.Ifitsmarginaltaxrateis35%,whatisLL’safter-taxcostofdebt?

9.5. SummerdahlResort’scommonstockiscurrentlytradingat$36ashare.Thestockisexpectedtopayadividendof$3.00ashareattheendoftheyear(D1=$3.00),andthedividendisexpectedtogrowataconstantrateof5%ayear.Whatisitscostofcommonequity?

9.6. BooherBookStoreshasa betaof0.8.Theyieldona3-monthT-billis4%,andtheyieldona10-year T-bondis6%.Themarketriskpremiumis5.5%,andthereturnonanaveragestockinthemarketlastyearwas15%.WhatistheestimatedcostofcommonequityusingtheCAPM?

9.8. DavidOrtizMotorshasatargetcapitalstructureof40%debtand60%equity.Theyieldtomaturityonthecompany’soutstandingbondis9%,andthecompany’staxrateis40%.Ortiz’sCFOhascalculatedthecompany’sWACCas9.96%.Whatisthecompany’scostofequitycapital?

Chapter 10

10.1. Aprojecthasaninitialcostof$40,000,expectednetcashinflowsof$9,000peryearfor7years,andacostofcapitalof11%.Whatistheproject’sNPV? (Hint:Beginbyconstructingatimeline.)

10.2. RefertoProblem10-1.Whatistheproject’sIRR?

10.3. RefertoProblem10-1.Whatistheproject’sMIRR?

10.4. RefertoProblem10-1.Whatistheproject’sPI?

10.5. RefertoProblem10-1.Whatistheproject’spaybackperiod?

10.6. RefertoProblem10-1.Whatistheproject’s discounted paybackperiod?

10.8. EdelmanEngineeringisconsideringincludingtwopiecesofequipment,atruckandanoveheadpulleysystem,inthisyear’scapitalbudget.Theprojectsareindependent.Thecashoutlayforthetruckis$17,100andthatforthepulleysystemis$22,430.Thefirm’scostofcapitalis14%.After-taxcashflows,includingdepreciation,areasfollows:

Year                                               truck                                                  Pulley

1                                                     $5,100                                                $7,500

2                                                5,100                                                      7,500

3                                                5,100                                                      7,500

4                                                5,100                                                      7,500

5                                                5,100                                                      7,500

CalculatetheIRR,theNPV,andtheMIRRforeachproject,andindicatethecorrectaccept–rejectdecisionforeach.

Chapter 11

11.1.TalbotIndustriesisconsideringlaunchinganewproduct.Thenewmanufacturingequipmentwillcost$17million,andproductionandsales willrequireaninitial$5millioninvestmentinnetoperatingworkingcapital.Thecompany’staxrateis40%.

a.Whatistheinitialinvestmentoutlay?

b.Thecompanyspentandexpensed$150,000onresearchrelatedtothenewproductlastyear.Wouldthischangeyouranswer?Explain.

1. Ratherthanbuildanewmanufacturingfacility,thecompanyplanstoinstalltheequipmentinabuildingitownsbutisnotnowusing.Thebuildingcouldbesoldfor$1.5millionaftertaxesandrealestatecommissions. How wouldthisaffectyouranswer?

11.2. ThefinancialstaffofCairnCommunicationshasidentifiedthefollowinginformationforthefirstyearoftheroll-outofitsnewproposedservice:

Projectedsales                                                                                                $18 million

Operatingcosts(notincludingdepreciation)                                            9 million

Depreciation                                                                                                        4 million

Interestexpense                                                                                                 3 million

Thecompanyfacesa40%taxrate.Whatistheproject’soperatingcashflowforthefirstyear(t=1)?

11.3. AllenAirlinesmustliquidatesomeequipmentthatisbeingreplaced.Theequipmentoriginallycost$12million,ofwhich75%hasbeendepreciated.Theusedequipmentcanbesoldtodayfor$4million,anditstaxrateis40%.Whatistheequipment’safter-taxnetsalvagevalue?

11.4. AlthoughtheChenCompany’smillingmachineisold,itisstillinrelativelygoodworkingorderandwouldlastforanother10years.Itisinefficientcomparedtomodernstandards,though,andsothecompanyisconsideringreplacingit.Thenewmillingmachine,atacostof$110,000deliveredandinstalled,wouldalsolastfor10yearsandwouldproduceafter-taxcashflows(laborsavingsanddepreciationtaxsavings)of$19,000peryear.Itwouldhavezerosalvagevalueattheendofitslife.Thefirm’sWACCis10%,anditsmarginaltaxrateis35%.ShouldChenbuythenewmachine?

11.6.TheCampbellCompanyisconsideringaddingaroboticpaintsprayertoitsproductionline.Thesprayer’sbasepriceis$1,080,000,anditwouldcostanother$22,500toinstallit.ThemachinefallsintotheMACRS3-yearclass,anditwouldbesoldafter3yearsfor$605,000.TheMACRSratesforthefirstthreeyearsare0.3333,0.4445,and0.1481.Themachinewouldrequireanincreaseinnetworkingcapital(inventory)of$15,500.Thesprayerwouldnotchangerevenues,butitisexpectedtosavethefirm$380,000peryearinbefore-taxoperatingcosts,mainlylabor.Campbell’smarginaltaxrateis35%.

a.WhatistheYear 0 netcashflow?

b.WhatarethenetoperatingcashflowsinYears1,2,and 3?

c.What is theadditionalYear-3cashflow(i.e.,theafter-taxsalvageandthereturnofworkingcapital)?

d.Iftheproject’scostofcapitalis12%,shouldthemachinebepurchased?

Chapter 23

23.1. ZhaoAutomotiveissuesfixed-ratedebtatarateof7.00%.ZhaoagreestoaninterestrateswapinwhichitpaysLIBORtoLeeFinancialandLeepays6.8%toZhao.WhatisZhao’sresultingnetpayment?

23.2. ATreasurybondfuturescontracthasasettlementpriceof89’08.Whatistheimpliedannualyield?