Evaluate project whether it should be undertaken

Question

Question 1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes    ___
Depreciation                                          ___
Earnings before taxes                             ___
Taxes @ 30%                                         ___
Earnings after taxes                                ___
Depreciation                                           ___
Cash flow                                               ___

Payback Method

1. Assume a $40,000 investment and the following cash flows for two alternatives.

Year      Investment X    Investment Y
1              $ 6,000           $15,000
2                 8,000             20,000
3                 9,000             10,000
4               17,000                —
5               20,000                —

Which of the alternatives would you select under the payback method?

Question 2: You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the internal rate of return?

Question 3: Warner Business Products is considering the purchase of a new machine at a cost of $11,070. The machine will provide $2,000 per year in cash flow for eight years. Warner's cost of capital is 13 percent.  Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.

Question 4: Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.

1.    Security Provision        2.  Yield to Maturity
a.    Debenture                           a. 6.85%
b.    Secured debt                       b. 8.20%
c.    Subordinated debenture        c. 7.76%       
       
Question 5: The Southeast Investment Fund buys 70 bonds of the Hillary Bakery Corporation through its broker. The bonds pay 9 percent annual interest. The yield to maturity (market rate of interest) is 12 percent.  The bonds have a 25-year maturity. Using an assumption of semiannual interest payments:

1. Compute the price of a bond (refer to “semiannual interest and bond prices” in Chapter 10 for review if necessary).

2. Compute the total value of the 70 bonds.       

Question 6: A 15-year, $1,000 par value zero-coupon rate bond is to be issued to yield 10 percent.

1. What should be the initial price of the bond? (Take the present value of $1,000 to be received after 15 years at 10 percent, using Appendix B at the back of the text.)

2. If immediately upon issue, interest rates dropped to 8 percent, what would be the value of the zero-coupon rate bond?

3. If immediately upon issue, interest rates increased to 12 percent, what would be the value of the zero-coupon rate bond?