Problem:
I would like the process to for these questions to be explained in plain language and systematically so I can grasp and understand. I am preparing for in-class exams so I need to ensure that I know and recognize what process should be used for the different problems. Thank you!
Question 1. The president of Crandall Ceramics is trying to decide whether or not to open a new location. The initial outlay required will be $1 million (fully depreciable) and the expected before-tax cash flows over each of the following 6 years are estimated to be either $500,000 or $250,000 depending on the state of the economy. Depreciation expense is taken on the basis of the MACRS three-year class. No working capital requirements for the project, but it will have a $100,000 salvage value at the end of year 6. Finally, Crandall faces a marginal tax rate of 40%. MACRS depreciation percentages for three-year class are 33%, 45%, 15%, and 7% respectively.
a. Find investment initial outlay
b. Find terminal (end-of-project) value
c. Find net operating cash flows for periods 1 - 6
d. Produce a timeline of cash flows for periods 0 - 6 (two sets of cash flows)
Question 2. Crandall will continue its current policy of financing all capital projects with a mix of 60% debt and 40% common equity. All debt financing is in the form of 6 year coupon bonds selling at par ($1000) with an annual coupon rate of 15%. Equity financing will come entirely out of retained earnings. The current stock price is $125/share, the most recent dividend was $4.55/share and dividends are expected to grow at a constant rate of 10% per year. Find Crandall's WAAC. (Hint: WAAC=wd rd (1-t) + Ws Ks)
Question 3. Calculate the NPV and IRR of the project for each possible state of the economy using WAAC from problem 2 (two). Economists predict a 30% chance of recession over the next six years, which would mean that Crandall's project would yield the lower NPV (this means 70% high value). Find the expected NPV and evaluate the project. Should Crandall pursue? Why?
Question 4. As CFO of Spice Girls Inc. you are considering two projects, each with a cost of capital of 12% with the following cash flows:
Period = 0 1 2 3 4
Project -1000 900 350 5 10
Project -1000 0 300 500 850
a. What is the IRR of each project?
b. What is the NPV of each project?
c. Which project should you choose if they are automatically exclusive?
d. Which project should you choose if they are independent?
Question 5. Durham's current tax rate and WAAC are 25% and 13%. Its current before-tax YTM on debt is 14% and its yield on retained earnings (equity) is 18%. Assuming Durham finances its investment projects solely with long-term debt and retained earnings. (What are the weights in the WAAC formula?) Hint: The weights must add to one.
Question 6. Metallic a Bearing, Inc. is a young start-up company. No dividend will be paid on the stock until five years have passed because the firm needs to plow back its earnings to fuel growth. The company will then pay a $6 per share dividend and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 23 percent, what is the current share price? (Hint: Find the share price for 5 years then discount it back to the present.)