1) Cairn Communications is trying to estimate the first-year operating cash flow (at t = 1) for a proposed project. The financial staff has collected the following information: Projected sales $10 million; Operating costs (not including depreciation) $ 7 million; Depreciation $ 2 million; Interest Expense $ 2 million. The company faces a 40% tax rate.
What is the project’s operating cash flow for the first year (t = 1)?
2) The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $50 million on a large-scale, integrated plant that will provide an expected cash flow stream of $8 million per year for 20 years. Plan B calls for the expenditure of $15 million to build a somewhat less efficient, more labor-intensive plant that has an expected cash flow stream of $3.4 million per year for 20 years. The firm’s cost of capital is 10%.
b. Set up a Project Δ by showing the cash flows that will exist if the firm goes with the large plant rather than the smaller plant. What are the NPV and IRR for this Project Δ?
3) Suppose the School Company has this book value balance sheet:
Current Assets 50,000,000; Fixed Assets $ 30,000,000; Total Assets $ 80,000,000
Current Liabilities $ 10,000,000 Long-term debt 30,000,000 Common equity Common stock (1 million shares) 1,000,000 Retained Earnings 39,000,000 Total Claims $ 80,000,000
The current liabilities consist entirely of notes payable to banks, and the interest rate on this debt is 10%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but instead are part of the company’s permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of $1,000, an annual coupon interest rate of 6%, and a 20-year maturity. The going rate of interest on new long-term debt, r_d , is 10%, and this is the percent yield to maturity on bonds. The common stock sells at a price of $60 per share.
Calculate the firm’s market value capital structure.