Bus 323 - Corporate Finance REVIEW QUESTIONS NOTE TO STUDENTS: Please note that the following questions are not in any way representative of your final exam. These questions are intended only to help you recall some of the concepts and problems we covered in class before. Also, to help you to practice your speed in solving problems. GOOD LUCK! 1. Liberty Bell is a successful holding company with investments in several fields. A new investment in video equipment with an initial outlay of $450,000 involves a risk factor determined to be 25% higher than its present portfolio of investments without presenting any diversification benefits. Revenue is projected to be $150,000 per year for 5 years at which time another capital outlay on equipment of $90,000 will be required. Expenses over this initial 5 year period will be $35,000 per year. Beginning in the sixth year revenues will increase by $50,000 a year, expenses increase by $10,000 and continue until year 10 when the business will be sold. The equipment will be sold for $60,000 (no recapture, capital gains, or terminal loss will be triggered). With a corporate tax rate of 47%, an overall cost of capital of 16% and a C.C.A rate on video equipment of 30%. REQUIRED: Calculate the NPV of this investment proposal indicating whether or not it should be accepted. CHECK FIGURE: (-$72,298) 2. Dryfuss Corp. is considering the replacement of one of its older machines that is still capable of doing the job but is considerably inefficient. A new machine costing $150,000 will reduce annual operating costs from $50,000 to $20,000 per year. The new machine will last ten years and will be depreciated for tax purposes at 30%. The older machine has a book value of $46,500 and a CCA rate of 30%. The older machine could be sold for $27,500 today. In ten years the new machine would be worth $32,000. It should also be noted that an installation of the new and clearing of the old machine will be incurred at an additional cost of $15,000. Dryfuss Corp.'s tax rate is 45% and its cost of capital is 13%. REQUIRED: a) Should the older machine should be replaced? Show all your calculations. (10 marks) CHECK FIGURE: (NPV -$644) b) Discuss what other factors, aside from your calculation above, you would consider before making your decision? (2 marks) 1 3. XYZ Video Ltd. is considering buying a small business computer costing $70,000. The presence of this machine is expected to save the wages of one full-time clerical worker and one part-time worker, an annual savings of $20,000. The computer has a useful life of seven years, will be depreciated on a 30% declining balance basis, and requires an additional $5,000 of working capital investment. Training of an operator for the computer would require an expenditure of $5,000 (considered an expense). The company's WACC is 13%; marginal tax rate is 40%. Salvage value at the end of year 7 is expected to be $10,000. Should the company acquire the machine? (NPV = -$1,260). 4. Quicky Courier Service Ltd. which has 40% tax rate wishes to acquire a $100,000 stamping machine. The machine has a CCA rate of 20%. It would be possible to secure a machine through an 8-year lease for $20,000 per year, payable in advance. The lessor will be responsible for regular maintenance cost of $200 a year if the machine is leased. Alternatively, it would be possible to borrow the $100,000 at 15%; this would require an annual payments of $22,285. At the end of eight years the machine could be sold for $10,000. Which is a better method of acquiring the machine? (CHECK FIGURE: NPV = -$71,812 FOR BORROW & BUY ALTERNATIVE) 5. The Common Divisor Corporation has 1 million shares of stock outstanding and intends to raise more equity capital by issuing an additional 200,000 shares. To ensure that the issue will be bought, Common Divisor is pricing the offer at $35.00, while the current market price is $43.00. Lotta Rice currently holds 220 shares. In the following, ignore all brokerage or underwriting costs. REQUIRED: a. Assuming that Common Divisor awards one right per share, how many rights in additional to $35.00 will be required to purchase a share of stock? (5) b. What will the ex-rights market value of a share of stock? (CHECK FIG. STOCK EX-RIGHT = $41.67) c. How many shares is Lotta entitled to buy at $35.00? (44) d. If Lotta decides not to buy any new shares, what can she sell her rights for? ($293.33) e. Verify that Lotta's net gain (or loss) is zero, whether she exercises her rights or sells them. f. How should Lotta dispose of her rights in such a way as to end up with exactly the same value in Common Divisor stock as she had before the rights offering? 2 6. The VP-Finance of Trojax Oil Co. is considering the issue of 5,000, 12%, 20 year convertible debentures with a conversion premium of 25% and a call price of $106. Trojax common stock currently earns $2.00 per share and sells at a price-earnings ratio of 20. The conversion price is $50. REQUIRED: a) What is the conversion ratio per $1,000 debenture?(20) b) What is the initial conversion value? ($800) c) How many new shares of common stock will be issued if there is a 100% conversion? (100,000) d) What is the debt value of one debenture (Pure Bond Value) if interest is paid annually and the market requires a return of 13% on investments of this type? ($929.75) e) Using your calculations in (c) and (e), at what minimum price should the convertible debenture sell? Why?(1000) 7. A company is considering the possibility of refunding $2 million of callable bonds issued ten years ago, that mature in 20 years. The new bonds could be issued at 12% per $1,000 per bond. The company would net $970 after payment of underwriting expenses associated with the issue. Other expenses associated with the issue amount to $21,000. The old bond has a 14% coupon rate and has an 11% call premium. There would be a 60-day overlap period. The company could invest excess funds without risk at 9%. The tax rate is 40%. Should the issue be refunded? (Check figure: NPV = (34,220) Do not refund. 3