Part -1:
Problem 1
LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL's after-tax cost of debt?
Problem 2
Summerdahl Resort's common stock is currently trading at $36 a share. The stock is expected to pay a dividend of $3.00 a share at the end of the year (D1 = $3.00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity?
Problem 3
Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%, and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 15%. What is the estimated cost of common equity using the CAPM?
Problem 4
David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.96%. What is the company's cost of equity capital?
Part -2:
Problem 1
A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the project's NPV? (Hint: Begin by constructing a time line.)
Problem 2
Refer to Problem 1. What is the project's IRR?
Problem 3
Refer to Problem 1. What is the project's MIRR?
Problem 4
Refer to Problem 1. What is the project's PI?
Problem 5 (Payback)
Refer to Problem 1. What is the project's payback period?
Problem 6 (Discounted payback)
Refer to Problem 1. What is the project's discounted payback period?
Problem 7 ( NPVs, IRRs, ans MIRRs for Independent projects)
Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year's 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 firm's cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:
| 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 |
Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept-reject decision for each.
Part -3:
Problem 1 (Investment outlay)
Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 40%.
a. What is the initial investment outlay?
b. The company spent and expensed $150,000 on research related to the new product last year. Would this change your answer? Explain.
c. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer?
Problem 2 (Operating cash flow)
The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service:
| Projected sales |
|
|
$18 million |
| Operating costs (not including depreciation) |
$ 9 million |
| Depreciation |
|
|
$ 4 million |
| Interest expense |
|
|
$ 3 million |
The company faces a 40% tax rate. What is the project's operating cash flow for the first year (t = 1)?
Problem 3 (Net salvage value)
Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $12 million, of which 75% has been depreciated. The used equipment can be sold today for $4 million, and its tax rate is 40%. What is the equipment's after-tax net salvage value?
Problem 4 (Replacement analysis)
Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The firm's WACC is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine?
Problem 5 (New-project Analysis )
The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor.
Campbell's marginal tax rate is 35%.
a. 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 project's cost of capital is 12%, should the machine be purchased?
Part - 4:
Problem 1 (Swaps)
Zhao Automotive issues fixed-rate debt at a rate of 7.00%. Zhao agrees to an interest rate swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao's resulting net payment?
Problem 2 (futures)
A Treasury bond futures contract has a settlement price of 89'08. What is the implied annual yield?
Attachment:- Problems.xlsx