Analyzing capital budgeting project


Question 1) Why is the capital budgeting decision such an important process? Why are managers focused on cash flows rather than on net income while analyzing capital budgeting project? Explain how you would incorporate risk in capital budgeting analysis.

Question 2) What are real options? Why it is important for managers to determine the value of real options in the capital budgeting decisions? Using an example explain how you can determine the value of a real option in the capital budgeting decision.

Question 3) Why do firms issue stock dividends? Comment on the following statement: "I have a stock that promises to pay a 20 percent stock dividend every year, and therefore guarantees that I will break even in 5 years."

Question 4) What are the three sources (balance sheet may help you) of corporate financing? Explain how managers make decisions on IPO's and the role of investment banking firm in the IPO.

Question 5) Based on the understanding of the corporate valuation model, identify at least three variables that you believe affect the value of the firm. Briefly, explain how the identified variables affect the value of the firm

Question 6) An analyst is interested in using the Black-Scholes model to value call option on the stock of ABC Corporation. The Analyst has accumulated the following information:

* The price of the stock is $40.
* The strike price is $38.
* The option matures in 90 days.
* Standard deviation of the stock return is 0.16.
* The risk-free rate is 5 percent.

Given the inforamtion, what is the value of the call option?

Question 7) ABC corporation is evaluating new equipment that will cost $300,000 and another $20,000 for shipping, and $10,000 for installation. The equipment is in the MACRS 3-year class and would be sold after 3 years for $30,000. Use of the equipment will require an additional $20,000 in inventory, and accounts payable will increase by $10,000. The equipment will not affect revenues, but will save $225,000 per year in operating costs. The company's tax rate is 40 percent and its cost of capital is 12%.

Part a. Calculate the cash flow in Year 0.
Part b. Calculate the incremental operational cash flows .

Reference:    MACRS Depreciation Percentages for three-year class life assets:
33%    45%    15%    7%

Part c. Calculate the terminal year cash flow.
Part d. Calculate the project's NPV.
Part g. Calculate the project's IRR.
Part i. Investment Decision: Should the project be accepted or rejected?

Question 8) Kanga Resorts is interested in developing a new facility in Asia. The company estimates that the hotel would require an initial investment of $14 million. The company expects that the facility will produce positive cash flows of $2.6 million a year at the end of each of the next 10 years. The project's cost of capitl is 12%.

a. Calculate the expected net present value of the project.

b. The company recognizes that the cash flows could, in fact, be much higher or lower than $2.6 million, depending on whether the host government imposes a large facility tax. One year from now, the company will know whether the tax will be imposed. There is a 40 percent chance that the tax will the imposed, in which case the yearly cash flows will be only $2 million. At the same time, there is a 60 percent chance that the tax will not be imposed, in which case the yearly cash flows will be $3 million. The company is deciding whether to proceed with the facility today or to wait 1 year to find out whether the tax will be imposed. If it waits 1 year, the initial investment will remain at $14 million. Assume that all cash flows are discounted at 12 percent. Calculate the value of the real option to wait a year before deciding.

Question 9) Capra's stock trades at $50 a share. The company is contemplating a 5-for-1 stock split. Currently, the company has EPS of $3.00, DPS of $1.00, and 10 million shares of stock outstanding. Assuming that the stock split will have no effect on the total market value of its equity;

a. What will be the company's stock price following the stock split?
b. How many shares of stock will be outstanding after the split?

Question 10). An investment banker enters into a best efforts arrangement to try and sell 10 million shares of stock at $15 per share for Pierre Imports. The investment banker incurs expenses of $300,000 in floating the issue and the company incurs expenses of $100,000. The investment banker will receive 10 percent of the proceeds of the offering.

a. If the offering is successful and sells out at the expected price of $15, how much money will the company receive?
b. If the offering is successful and sells out at the expected price of $15, how much money will the investment banker receive?
c. If the offering is partially successful; all shares are sold, but at a price of $10. How much does the company receive?
d. If the offering is partially successful; all shares are sold, but at a price of $10. How much does the investment banker receive?

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Finance Basics: Analyzing capital budgeting project
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