a. List at least three of the defects that appear in the treasurer's analysis: HINT: there are five altogether

b. Weighted average cost of capital:

Source Proportion Cost Rate Weighted Cost

Bonds 10% x 8% = 0.80% Check figure: Bonds percents are given for you

Stock x 9 =

Retained earnings x 10 =

Totals

Provide the "buffer margin" in the box

Cutoff rate for net present value analysis

We may compute the annual after-tax cash flows by computing and combining the individual after-tax cash effects. The individual effects are determined by multiplying both the cash revenue and cash expenses by 70% (1 - income tax rate) and multiplying the patent amortization by 30% (the income tax rate).

There are 3 steps to calculate After - Tax Cash Flow - I have provided Year 1 for you:

Year 1: $620,000 x 70% = 434,000

(240,000) x 70% = -168,000

144,000 x 30% = 43,200

After-tax cash flow 309,200

Year 2: $560,000 x 70% =

After-tax cash flow

Year 3: $400,000 x 70% =

After-tax cash flow

Year 4: $250,000 x 70% =

After-tax cash flow

Year 5: $200,000 x 70% =

After-tax cash flow

After-tax Present

Year (N) Cash Flows (FV) i/Yr Value Show your work here (first one provided for you)

1 $309,200 @ 12% = 276,071 PV = $309,200 x 0.89286 = $276,072 (difference due to rounding)

2 @ 12% =

3 @ 12% =

4 @ 12% =

5 @ 12% =

Total present value

Investment required

Net positive present value

What is the recommendation:

c - 1 Year (N)

Original After Tax Cash Flows

(10% Revenue Reduction) x 1 - Tax Rate)

Revised After Tax Cash Flows (FV)

i/Yr Present Value

1 309,200 = (62,000 x 70%) = 265,800 @ 12% = 237,321 PV = $265,800 x .89286 = $237,322

2 = = @ 12% =

3 = = @ 12% =

4 = = @ 12% =

5 = = @ 12% =

Total present value

Investment required

Net positive present value

What is the conclusion:

investment opportunity its line of CD recorders G YOUR KNOWLEDGE last for five more EYK12-1. Business Decision expenditure analysis below Business Decision Case New Haven Corporation recently identified an inye involving the purchase of a patent that will permit the company to modify its line The patent's purchase price is $720,000 and the legal protection it provides w years, there is no salvage value. However, after preparing the capital expendit New Haven's treasurer has recommended to the company s capital budgeting co investment be rejected. Brad Decker, chairperson of the capital budgeting committee cult to accept the treasurer's analysis because he "feels intuitively that the investmen For this reason, he has retained you to review the treasurer's analysis and recomme are provided with the following data and summary of the treasurer's analysis: committee that the mittee, finds it diffi- estment is attractive, commendation. You on a straight-line basis, 1. Required investment: $720.000 cash for the patent to be amortized on a straight five-year useful life, with a zero salvage value. 2. Projected cash revenue and operating expenses: Cash Revenue Year $ 620,000 560,000 400,000 250,000 200,000 $2,030,000 Cash Expenses $240,000 200,000 170,000 80,000 50,000 $740,000 3. Source of capital: New Haven plans to raise 10% of the needed capital by issuing bonds, 30% by issuing stock, and the balance from retained earnings. For these sources, the capital cost rates are 8%, 9%, and 10%, respectively. New Haven has a policy of seeking a return equal to the weighted average cost of capital plus 2.5 percentage points as a "buffer margin" for the uncertainties involved. Income taxes: New Haven has an overall income tax rate of 30%. 5. Treasurer's analysis: $2,030,000 $740,000 720.000 Average cost of capital (8% + 9% + 10%)/3 - 9% Total cash revenue.. Total cash expenses.... Total amortization. Total operating expenses . . . . . . . . . . Projected net income over five years. Average annual income Present value of future returns . . . . . . Required investment. Negative net present value. .......... 1,460,000 $ 570,000 $ 114,000 $ 443,420 720,000 $ (276,580) Recommendation: Reject investment because of insufficient net present value. Required d. Review the treasurer's analysis, identifying any questionable aspects and briefly comment on the apparent effect of each such item on the treasurer's analysis. b. Prepare your own analysis of the investment, including a calculation of the proper cost of capital and hurdle rates, a net present value analysis of the project, and a brief recommenda- tion to Decker regarding the investment (round amounts to nearest dollar). ic. Because of his concern for the uncertainties of the CD recorder business, Decker also has asked you to provide analyses supporting whether or not your recommendation would change 1. If estimates of projected cash revenue were reduced by 10%. 2. If the "buffer margin" were tripled from 2.5% to 7.5%. Campany's cutting department, which