Problem 1) Each of the following investment opportunities would cost $55,000. Using the following information, calculate the payback period for each proposed investment. In addition, which project would you select based on the payback method of analysis? Why? Finally, what short comings do you see with the payback method of analysis?
Year Project A Project B
1 $5,000 $25,000
2 5,000 17,000
3 10,000 17,000
4 15,000 0
5 15,000 0
6 25,000 0
Problem 2) The Management of Ink's Inc. is evaluating the following investment opportunity which will cost the firm $81,383.53 if undertaken. In addition, it is projected that the following after-tax returns will be generated from the project.
Year Cash Flow
1 $20,000
2 25,000
3 30,000
4 35,000
What will the NPV be on the proposed project based on a weighed average cost of capital of 9%? Additionally, what will the project's IRR be?
Problem 3) Pilot Corporation has the following current capital structure, which is considered optimal:
Bank Loans $25,000
Bonds $35,000
Preferred Stock $65,000
Common Stock $80,000
Pilot is paying interest at a rate of 12% on its' outstanding loans, a 10% rate of return on its' outstanding bonds, a 12% rate of return on its' preferred stock, and its' common stockholders require an 8% rate of return. The firms' marginal tax rate is 40%. Based on the information provided, calculate the firms' weighted average cost of capital. In addition, explain what a firms' weighted average cost of capital represents. Finally, how is the firms' weighted average cost of capital utilized by management?
Problem 3: Tech Pro Inc. is investigating the feasibility of introducing a new high tech baseball bat. Based on research, conducted by the firm, unit sales are projected to be as follows:
Year Unit Sales
1 5,000
2 6,000
3 7,000
4 8,000
The new bat would be priced at $225.00 per unit. The variable cost per unit will be $110.00, and fixed cost will be $42,000.00 per year. The new bat will require $30,000.00 in new net working capital at the start.
It will cost $780,000.00 to buy the equipment necessary to begin production. In addition, the equipment will cost $40,000.00 to setup. The equipment will be classified as three year MACRS property. The equipment will have a salvage value of $10,000.00 at the end of the four years. The firms marginal tax rate is 35% and its' weighted average cost of capital is 12%. Using the NPV method of analysis, determine whether the firm should undertake the proposed project. Why or why not? Bonus, what is the IRR on the proposed project?
Additional information: Depreciation Table
Year 3 Year Property
1 33.33%
2 44.44%
3 14.82%
4 7.41%