1. You are a budget analyst at Global Motors and gave been asked to evaluate the following proposal. The company is considering replacing its existing metal stamping press with a new fully automated press for its luxury car line. If done, this would produce future savings value TODAY at $350,000. The new automated stamping machine requires an initial investment of $405,000 and the existing production equipment can be salvaged or sold for $85,000. Use marginal cost-benefit analysis to determine the following:
a. The marginal (incremental) benefit of the proposed new robotic
b. Marginal (incremental) cost of new robotics:
c. Net benefit of proposed new robotics:
d. Should you recommend the new robotics system? Why or why not?
2. Which one of the following is false?
a. In a world where interest is not tax deductible, a firm’s capital structure is irrelevant meaning that WACC is constant for all levels of D/E
b. The WACC always reflects the required return on a firm’s assets regardless of whether or not interest expense is tax deductible.
c. If interest expense is a tax deductible, a new asset is created that equals the present value of the interest tax shield. This new asset is a wealth transfer from the Federal Government (IRS) to the company’s shareholders.
d. A firm’s cost of equity increases with increasing D/E due to greater financial risk associated with higher leverage
e. In a world where interest expenses is tax deductible and bankruptcy costs are high, there is an optimal capital structure that maximizes the value of the firm. This occurs when the increase in the interest tax shield is offset by higher expected bankruptcy costs.
f. When using the beta of a comparable “pure play” firm to find the cost of capital of a privately held company, one only needs to consider the business risk. Adjusting for the financial risk of the comparable firm is not relevant when using its beta.