Problem 1. Regina is analyzing the acquisition of another car which would require an initial investment of $95,000. It expects cash flows of $35,000/year over the next four years.
a. On a cost of capital of 14% is the investment worth making?
b. Would your decision change if the cash flows were adjusted for less than 100% certainty after the first year with an adjustment factor of 96% for year two and factors of .92, and .85for the remaining two years?
Problem 2. Regina Inc is considering a new production line for its rapidly expanding camping equipment division. The new line will cost $480,000, and will be depreciated on a straight line basis ($160,000/yr.) over the next 3 years leaving no residual value. Other important factors are 1) new sales for each of the next 3 years will be $475,000, $550,000 and $600,000, 2) cost of goods sold, exclusive of depreciation, is 40% of sales, 3) increased G&A and Selling expenses are estimated to be $40,000 per year, and 4) the company's cost of capital is 18% with a tax rate of 40%.
a. What is the project's NPV?
b. What are the project's annual cash flows?
c. What is the approximate IRR?
Problem 3. Michael Inc has a capital structure that consists of
Bond Issue A @ a rate of 11% $22,000,000
Bond Issue B @ a rate of 13% 10,000,000
Preferred Stock 6,000,000
Common Stock (100,000 shares outstanding) 4,000,000
Retained Earnings 15,000,000
The preferred stock pays a dividend of $7.85 and $52 was received from the initial sale. The common stock paid a $2.50 dividend last year and sells for $28.90 in the market. The company has an expected annual growth rate of 6%.
The appropriate cost of capital to be used for capital budgeting projects is ___________.