1) Suppose that you are the financial manager of Onyx Corp. This firm considers to buy a machine in 2020 whose cost is $ 10 000 000. The cost of investment is paid in 2020. The expected lifetime of the machine is 5 years. That machine is subject to 5-year straight line depreciation allowing the firm to write off a $ 2 000 000 depreciation expense in each year from 2021 to 2025. The firm wants to know if that investment is feasible given the following information The last available balance sheet of that firm is as follows: Assets: Current Assets: $ 60 000 000 Long-Term Assets: $200 000 000 Total Assets: $ 260 000 000 Liability and Equity: Accrued Expenses $ 3 000 000 Account Payables $ 7000 000 Short-Term Loan $50 000 000 Long-Term Loan $ 100 000 000 Equity as Preferred Stock: $ 20 000 000 Equity as Common Stock: $ 80 000 000 Total Liab, and Equity $ 260 000 000 200 The following information is also given: The firm has one short-term loan and the firm pays an annual interest rate of 10% on this loan. The firm has one long-term loan of $ 100 000 000 and the firm pays an annual interest rate of 12% on that long-term loan. The corporate tax rate is 20% The firm expects to pay a dividend of $3 per share to preferred stock holders next year and to pay a dividend of $ 2.5 per share to common stock holders next year. The current market value of the preferred stock is $ 30 per share and the current market value of the common stock is $ 25 per share. Onyx Corp. uses dividend discount method to find the cost of equity and expects an annual growth rate of 5% in future dividends. This investment is expected to increase the sales revenue of the firm as follows 2021 2022 2023 2024 2025 $ 5 000 000 $ 7 000 000 $ 8 000 000 $ 6 000 000 $ 5 000 000 The COGS (Cost of Goods Sold) of that investment is 40% of the sales revenue and the general administrative costs of that investment is 10% of the sales revenue in each of the years above. This investment is expected to increase the inventories by $ 200 000 in 2021. It is also estimated that accounts receivables will increase by $ 300 000 in 2021 and account payables will increase by $ 100 000 in 2021 because of that investment. There will be no change in inventories, account receivables and account payables in the years 2022 and 2023. The firm expects that inventories will decline by $ 50 000, account receivables will decline by $ 70 000 and account receivables will decline by $ 20 000 in 2024. All the remaining inventories wil be sold in 2025 and all remaining account receivables will be received in 2025. The firm also will pay all remaining account payables in 2025. Finally, the firm estimates that it can sell this machine by the end of 2025 for a value of $ 1 300 000 (salvage value of the machine is $ 1 300 000). Given that information a) Find the relevant discount rate (WACC) of that firm b) Estimate the operating cash flow and the net cash flow of that firm for years 2021.2022 2023, 2024 and 2025 using information above. c) Calculate the net PV of that investment using the discount rate (WACC) that you will find in 1a above and decide if that investment is feasible or not. Also mention how much the value of the firm may increase by that investment Note: Use up to 4 decimals (e.g 0.1721) in your calculations. 2) A firm faces two alternative investment projects A and B and wants to choose one of them. The relevant information for these projects is as follows: Project A Cost of Investment: $ 7 000 000 (paid in 2020) Lifetime: 6 years Expected Cash Flows: 2021 $ 3 000 000 $ 4 000 000 2022 2023 2024 2025 2026 $ 5 000 000 $ 4 000 000 $ 2 800 000 $ 2 500 000 The firm do not expect any salvage value in that investment (expected salvage value of Project A is 0) Project B: Cost: $ 10 000 000 (paid in 2020) Lifetime: 6 years Expected Cash Flows: 2021: $ 2 000 000 2022: $ 2 000 000 2023: $ 3 000 000 2024: $ 4 000 000 2025: $ 6 000 000 2026: $ 6 000 000 The firm expects to have a salvage value of $ 2 000 000 in 2026 for Project B. Firm uses a discount rate of 10% for both project A and project B. a) Calculate exact payback period of Project A and Project B using Simple Payback Method. b) Assume that the desired payback period for the Simple Payback Method is 3 years for Project A and also for Project B. Which one of the projects will be chosen by the firm in that case? c) Calculate the exact payback period of both Project A and Project Busing Discounted Payback Period. d) Assuming that the desired payback periods of both Project A and Project B is 3 years; which one of the projects will be chosen by that 5 firm if that firm uses Discounted Payback Method to evaluate these investments? e) Calculate the net PV of Project A and Project B. Which project will be chosen by the firm if the firm uses net PV method to evaluate the investments ? f) Do these three methods choose the same investment as the better investment? If not, then which method's choice must be accepted by the firm? 3) A firm considers to buy a machine in 2020. The cost of that machine is $ 5 000 000. The firm uses 5 year straight line depreciation which allows it to write off $ 1 000 000 depreciation expense each year. The firm is subject to 20% corporate tax rate. The firm's revenue in 2021 is expected to be $ 6 000 000 if the investment is not done. The revenue will be $ 9 000 000 if the investment is done. The firm's total costs (including both COGS and General&Administrative Costs) will be $ 4 000 000 if the investment is not done. The total costs will be $ 5 500 000 if the investment is done. Also the following information is given for the year 2021 Without Investment With Investment Inventories $ 300 000 $ 500 000 Acc. Receivables $ 200 000 $ 300 000 Acc. Payables $ 100 000 $ 150 000 Given the above information: calculate the free cash flow of that investment for the years 2020 and 2021. 4) The firms use both Net PV method and IRR (Internal Rate of Return) Method to evalauate investments. The IRR method, however, have some problems. The three problems cited regarding IRR are a) Re-investment assumption b) Multiple Root Problem c) Unconventional Cash Flow Problem. What are these problems? Explain these problems clearly by giving examples if necessary Evaluation of Questions: 1) Suppose that you are the financial manager of Onyx Corp. This firm considers to buy a machine in 2020 whose cost is $ 10 000 000. The cost of investment is paid in 2020. The expected lifetime of the machine is 5 years. That machine is subject to 5-year straight line depreciation allowing the firm to write off a $ 2 000 000 depreciation expense in each year from 2021 to 2025. The firm wants to know if that investment is feasible given the following information The last available balance sheet of that firm is as follows: Assets: Current Assets: $ 60 000 000 Long-Term Assets: $200 000 000 Total Assets: $ 260 000 000 Liability and Equity: Accrued Expenses $ 3 000 000 Account Payables $ 7000 000 Short-Term Loan $50 000 000 Long-Term Loan $ 100 000 000 Equity as Preferred Stock: $ 20 000 000 Equity as Common Stock: $ 80 000 000 Total Liab, and Equity $ 260 000 000 200 The following information is also given: The firm has one short-term loan and the firm pays an annual interest rate of 10% on this loan. The firm has one long-term loan of $ 100 000 000 and the firm pays an annual interest rate of 12% on that long-term loan. The corporate tax rate is 20% The firm expects to pay a dividend of $3 per share to preferred stock holders next year and to pay a dividend of $ 2.5 per share to common stock holders next year. The current market value of the preferred stock is $ 30 per share and the current market value of the common stock is $ 25 per share. Onyx Corp. uses dividend discount method to find the cost of equity and expects an annual growth rate of 5% in future dividends. This investment is expected to increase the sales revenue of the firm as follows 2021 2022 2023 2024 2025 $ 5 000 000 $ 7 000 000 $ 8 000 000 $ 6 000 000 $ 5 000 000 The COGS (Cost of Goods Sold) of that investment is 40% of the sales revenue and the general administrative costs of that investment is 10% of the sales revenue in each of the years above. This investment is expected to increase the inventories by $ 200 000 in 2021. It is also estimated that accounts receivables will increase by $ 300 000 in 2021 and account payables will increase by $ 100 000 in 2021 because of that investment. There will be no change in inventories, account receivables and account payables in the years 2022 and 2023. The firm expects that inventories will decline by $ 50 000, account receivables will decline by $ 70 000 and account receivables will decline by $ 20 000 in 2024. All the remaining inventories wil be sold in 2025 and all remaining account receivables will be received in 2025. The firm also will pay all remaining account payables in 2025. Finally, the firm estimates that it can sell this machine by the end of 2025 for a value of $ 1 300 000 (salvage value of the machine is $ 1 300 000). Given that information a) Find the relevant discount rate (WACC) of that firm b) Estimate the operating cash flow and the net cash flow of that firm for years 2021.2022 2023, 2024 and 2025 using information above. c) Calculate the net PV of that investment using the discount rate (WACC) that you will find in 1a above and decide if that investment is feasible or not. Also mention how much the value of the firm may increase by that investment Note: Use up to 4 decimals (e.g 0.1721) in your calculations. 2) A firm faces two alternative investment projects A and B and wants to choose one of them. The relevant information for these projects is as follows: Project A Cost of Investment: $ 7 000 000 (paid in 2020) Lifetime: 6 years Expected Cash Flows: 2021 $ 3 000 000 $ 4 000 000 2022 2023 2024 2025 2026 $ 5 000 000 $ 4 000 000 $ 2 800 000 $ 2 500 000 The firm do not expect any salvage value in that investment (expected salvage value of Project A is 0) Project B: Cost: $ 10 000 000 (paid in 2020) Lifetime: 6 years Expected Cash Flows: 2021: $ 2 000 000 2022: $ 2 000 000 2023: $ 3 000 000 2024: $ 4 000 000 2025: $ 6 000 000 2026: $ 6 000 000 The firm expects to have a salvage value of $ 2 000 000 in 2026 for Project B. Firm uses a discount rate of 10% for both project A and project B. a) Calculate exact payback period of Project A and Project B using Simple Payback Method. b) Assume that the desired payback period for the Simple Payback Method is 3 years for Project A and also for Project B. Which one of the projects will be chosen by the firm in that case? c) Calculate the exact payback period of both Project A and Project Busing Discounted Payback Period. d) Assuming that the desired payback periods of both Project A and Project B is 3 years; which one of the projects will be chosen by that 5 firm if that firm uses Discounted Payback Method to evaluate these investments? e) Calculate the net PV of Project A and Project B. Which project will be chosen by the firm if the firm uses net PV method to evaluate the investments ? f) Do these three methods choose the same investment as the better investment? If not, then which method's choice must be accepted by the firm? 3) A firm considers to buy a machine in 2020. The cost of that machine is $ 5 000 000. The firm uses 5 year straight line depreciation which allows it to write off $ 1 000 000 depreciation expense each year. The firm is subject to 20% corporate tax rate. The firm's revenue in 2021 is expected to be $ 6 000 000 if the investment is not done. The revenue will be $ 9 000 000 if the investment is done. The firm's total costs (including both COGS and General&Administrative Costs) will be $ 4 000 000 if the investment is not done. The total costs will be $ 5 500 000 if the investment is done. Also the following information is given for the year 2021 Without Investment With Investment Inventories $ 300 000 $ 500 000 Acc. Receivables $ 200 000 $ 300 000 Acc. Payables $ 100 000 $ 150 000 Given the above information: calculate the free cash flow of that investment for the years 2020 and 2021. 4) The firms use both Net PV method and IRR (Internal Rate of Return) Method to evalauate investments. The IRR method, however, have some problems. The three problems cited regarding IRR are a) Re-investment assumption b) Multiple Root Problem c) Unconventional Cash Flow Problem. What are these problems? Explain these problems clearly by giving examples if necessary Evaluation of Questions
