PROBLEM SOLVING: For each problem-solving question, show your work on your spreadsheet and record your final answer on the space provided under each question:
Q1. As the director of capital budgeting for Colorado Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:
|
Year
|
Project A Cash Flow ($)
|
Project B Cash Flow ($)
|
|
Given Colorado's cost of capital is 12 percent:
|
0
|
-165,000
|
-130,000
|
|
a) (5 pts) NPV and IRR of project A are $............................ and ...............%.
|
1
|
40,000
|
15,000
|
|
b) (5 pts) NPV and IRR of project B are $............................ and ...............%.
|
2
|
55,000
|
25,000
|
|
c) (3 pts) I would choose ............................. , because...........................
|
3
|
42,000
|
42,000
|
|
4
|
35,000
|
61,000
|
|
5
|
60,000
|
50,000
|
Q2. Lloyd Enterprises has a project which has the following cash flows:
|
Year
|
Cash Flows ($)
|
|
0
|
-180,000
|
|
1
|
25,000
|
|
2
|
90,000
|
|
3
|
135,000
|
|
4
|
140,000
|
|
5
|
39,000
|
The cost of capital is 8 percent.
The project's discounted payback period is ..............years.
Q3. Northwest Corporation is estimating its WACC. Its target capital structure is 30 percent debt and 70 percent common equity. Its bonds have a 10 percent coupon, paid semiannually, and a current maturity of 20 years. Bonds also have current market value of $1,100 and par value of $1,000. Northwest' beta is 1.35, the risk free rate is 3.5 percent, and the market risk premium is 7 percent. Northwest is a constant-growth firm which just paid a dividend of $2.40, its stock sells for $24.00 per share, and has a growth rate of 4 percent. The firm's marginal tax rate is 40 percent.
a) What is Northwest' before-tax cost of debt?
b) What is the firm's cost of common stock (RE) (rs) using the DCF approach?
c) What is Northwest' WACC?
Q4. The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a labeling machine. The purchase price of machine is $57,000 with an additional shipping cost of $5,000, and it falls into the MACRS 3-year class (depreciation rates are 33%, 45% 15%, 7% respectively). Purchase of machine would require one time increase in net operating working capital of $7,000. The project would increase the firm's before-tax revenues by $29,000 per year but would also increase operating costs by $8,000 per year. The machine is expected to be used for 3 years and then be sold for $27,500. The firm's marginal tax rate is 40%, and the project's cost of capital is 11%.
a) What is the initial cash outflow required at t = 0?
b) What is the operating cash flow in Year 2?
c) What is the non-operating (terminal) cash flows at the end of Year 3?
d) What are the NPV and IRR of the project?