Problem 1: Your Company is considering a new project that will require $1,066,000 million of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $156,000 using straight-line depreciation. Neither bonus depreciation nor Section 179 expensing will be used. The cost of capital is 13 percent, and the firm's tax rate is 21 percent.
Required: Estimate the present value of the tax benefits from depreciation.
Problem 2: You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $70,000, has a 5-year life, and has an annual OCF (after-tax) of -$11,300 per year. The Keebler CookieMunster costs $96,500, has a 7-year life, and has an annual OCF (after-tax) of -$9,300 per year.
Required: If your discount rate is 11 percent, what is each machine's EAC?
Problem 3: Suppose that Lil John Industries' equity is currently selling for $32 per share and that 2.5 million shares are outstanding. The firm also has 55,000 bonds outstanding, which are selling at 104 percent of par. Assume Lil John was considering an active change to its capital structure so that the firm would have a Debt to Equity ratio (D/E) of 1.3.
Required:
A) Which type of security (stocks or bonds) would it need to sell to accomplish this?
a. sell bonds and buy back stock
b. sell stocks and buy back bonds
B) How much would the firm have to sell?
Problem 4: Daddi Mac, Inc. doesn't face any taxes and has $251.60 million in assets, currently financed entirely with equity. Equity is worth $32 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below:
|
State
|
Recession
|
Average
|
Boom
|
|
Probability of state
|
0.2
|
0.55
|
0.25
|
|
Expected EBIT in state
|
$5,535,200
|
$10,504,300
|
$17,549,100
|
The firm is considering switching to a 20-percent-debt capital structure and has determined that it would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if the firm switches to the proposed capital structure?