1. Consider the following mutually exclusive pieces of equipment that perform the same task. The two alternatives available provide the following set of after-tax net cash flows:

Year

Cash Flow(A)

Cash Flow(B)

0

($120,000)

($120,000)

1

23,000

25,000

2

23,000

25,000

3

23,000

25,000

4

32,000

25,000

5

32,000

25,000

6

32,000

25,000

7

25,000

8

25,000

9

25,000

Equipment A has an expected life of six years, whereas equipment B has an expected life of nine years. Assume a required rate of return of 8 percent.

a. Calculate each equipments payback period. (2 points)

b. Calculate each equipments discounted payback period. (4 points)

c. Calculate each equipments Net Present Value (NPV). (4 points)

d. Calculate each equipments internal rate of return. (4 points)

e. How would you rank the investments based on the NPV criterion? (1 point)

f. How would you rank the investments based on the IRR criterion? (1 point)

g. The ________ assumes the reinvestment of funds at a rate equal to the equipments IRR. (1 point)

h. The _______ assumes the reinvestment of funds at the firms cost of capital. (1 point)

2. The General Motors Corporation is introducing a new product and which is expected to result in change in EBIT or $700,000.

The firm has a 30 percent marginal tax rate. This product will also produce $180,000 of depreciation per year. In addition, this product will cause the following changes:

Balance Sheet Account

Without the product($)

With the product ($)

Accounts receivable

75,000

95,000

Inventory

85,000

165,000

Accounts payable

45,000

70,000

a. Calculate the change in net working capital? (3 points)

b. Calculate the products change in taxes. (2 points)

c. What is the products free cash flow? (5 points)

3. FITCO Inc. is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share.

The new production line will cost $1,550,000 for manufacturing the parts and an additional $130,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $400,000.

The equipment line will generate additional annual revenues of $865,000, and will have additional annual operating expenses of $500,000. project.

FITCO is in the 35 percent tax bracket, and its existing cost of capital is 6 percent.

An inventory investment of $90,000 is required during the life of the project. FITCO is in the 35 percent tax bracket, and its existing cost of capital is 6 percent.

A. Calculate the initial outlay of the project. (3 points)

B. Calculate the annual after-tax operating cash flow for Years 1 -4. (8 points)

C. Determine the terminal year (in year 4) after-tax non-operating cash flow. (3 points)

D. What is the equipments NPV? (3 points)

E. What is the estimated Internal Rate of Return (IRR) of the project? Should the project be accepted based on the IRR criterion?

(3 points)

4. Determine the IRR on the following projects:

a) An initial outlay of $10,000 resulting in a free cash flow of $2,146 at the end of each year for the next 10 years. (2 points)

b) An initial outlay of $15,000 resulting in a free cash flow of $3,500 at the end of each year for the next 5 years. (2 points)

c) An initial outlay of $10,000 resulting in a free cash flow of $1,960 at the end of each year for the next 20 years. (2 points)

5. What is the companys cost of equity capital if MJIs common stock has a beta of 1.0, a risk-free rate of 6 percent and the expected return on the market is 12 percent? (3 points)

6. Consider GRENLEC Power Co. which has the following information about its capital structures:

Debt - 4,500 issues 6 percent coupon bonds outstanding, $1,000 par value, 7 years to maturity, selling for 93 percent of par, the bonds make semiannual payments

Common Stock - 150,000 shares outstanding, selling for $35 per share; the beta is 1.10

Preferred Stock - 80,000 shares of 6 percent preferred stock outstanding, currently selling for $95 per share

Market Information - 6 percent market risk premium and 4 percent risk-free rate.

Required: Calculate to the following if the company has a tax rate of 36 percent.

i. Total Market Value for the Firm ( 3 points)

ii. After-tax cost of Debt (3 points)

iii. Cost of Equity (2 points)

iv. Cost of Preferred Stock (2 points)

v. Weighted Average Cost of Capital (3 points)

7. The total market value for Disney was $490M at the start of this year. During the year Disney plans to raise and invest $200M in new projects.

The companys present market value capital structure, shown below is considered to be optimal. Assume that there is no short-term debt. Debt $155M; Common equity $335M; Total Capital $490M.

New bonds will have an 8 percent coupon rate, and they will be sold at par. Common stock is currently selling at $55 a share and has of a dividend yield of 6 percent and an expected constant growth rate of 4

percent. The marginal corporate tax rate is 30 percent.

a. Assume that there is sufficient cash flow such that Disney can maintain its target capital structure without issuing additional shares of equity.

i. Calculate the after-tax cost of debt. (2 points)

ii. Calculate the Cost of Equity. (2 points)

iii. What is the WACC? (3 points)

b. To maintain the present capital structure, how much of the new investment must be financed by common equity? (3 points