1. Differentiate between sunk costs and opportunity costs. Which of these costs should be included in incremental cash flows, and which should be excluded?

1. Advancedtronics Corporation is considering purchasing a new packaging machine to replace a fully depreciated packaging machine that will last five more years. The new machine is expected to have a 5-year life and depreciation charges of $4,000 in year 1; $6,400 in year 2; $3,800 in year 3; $2,400 in both year 4 and year 5; and $1,000 in year 6. The firms estimates of revenues and expenses (excluding depreciation) for the new and old packaging machines are shown in the following table. Advanced Electronics is subject to a 30 % tax rate on ordinary income.

	New Packaging Machine .	Old Packaging Machine .
Year	Revenue	Expenses (excluding depreciation)	Revenue	Expenses (excluding depreciation)
1	$50,000	$40,000	$45,000	$35,000
2	$51,000	$40,000	$45,000	$35,000
3	$52,000	$40,000	$45,000	$35,000
4	$53,000	$40,000	$45,000	$35,000
5	$54,000	$40,000	$45,000	$35,000

a. Calculate the operating cash flows associated with each packaging machine. Be sure to consider the depreciation in year 6.

b. Calculate the incremental operating cash flows resulting from the proposed packaging machine replacement.

c. Depict on a time line the incremental operating cash flows found in part (b.).

3. You have a trust fund that will pay you $1 million exactly 10 years from today. You want cash now, so you are considering an opportunity to sell the right to the trust fund to an investor.

a. What is the least you will sell your claim for if you could earn the following rates of return on similar-risk investments during the 10-year period?

1. 6 %

2. 9 %

3. 12 %

b. Rework part (a) under the assumption that the $1 million payment will be received in 15 rather than 10 years.

c. Based on your findings in parts (a) and (b), discuss the effect of both the size of the rate of return and the time until receipt of payment on the present value of a future sum.

1. Liliana Alvarezs employer offers its workers a two-month paid sabbatical every seven years. Liliana, who just started working for the company, plans to spend her sabbatical touring Europe at an estimated cost of $25,000. To finance her trip, Liliana plans to make six annual end-of-year deposits of $2,500 each, starting this year, into an investment account earning 8% interest.

a. Will Lilianas account balance at the end of seven years be enough to pay for her trip?

b. Suppose Liliana increases her annual contribution to $3,150. How large will her account balance be at the end of seven years?

5. To supplement your planned retirement, you estimate that you need to accumulate $220,000 in 42 years. You plan to make equal annual end-of-year deposits into an account paying 8 % annual interest.

a. How large must the annual deposits be to create the $220,000 fund in 42 years?

b. If you can afford to deposit only $600 per year into the account, how much will you have accumulated by the end of the forty-second year?

1. Why are most corporate bonds callable? Who benefits from this feature, and what is the cost of adopting a call provision in a public bond issue?

Since graduation from college, you have worked at Precision Manufacturing Pty Ltd, as a financial analyst. You have recently been promoted to the position of senior financial manager, with responsibilities that include capital budgeting decisions and the raising of long-term financing. Therefore, you decide to investigate the various alternatives for raising funds. Your goal is to make sure that the benefits received from undertaking long-term projects are greater than the costs of raising the long-term funds needed to finance those projects. With this goal in mind, you decide to answer the following questions.

7. Question

1. What should managers consider when making the decision whether to finance internally or externally?

2. What services does an investment banker offer to businesses that choose to raise funds in the capital market?

3. What are the benefits to the company of going public?

4. What are the drawbacks to the corporation of going public?

5. What returns can investors in the ordinary equity expect on the first day of trading if they commit to purchase shares through the IPO issue? What factors may affect the relative amount of these first-day returns?

6. Describe the following offers: (a) seasoned equity offer; (b) rights offer, and (c) private placement. In what circumstances would a company use each of these offerings to raise funds?

7. Discuss the differences between international public offerings and domestic (US) public offerings.

1. You have gathered the following data on three bonds (each with a face value of $1,000):

Bond Maturity Coupon %

A 10 yrs 9%

B 9 yrs 1%

C 5 yrs 5%

a. If the markets required return on all three bonds is 6%, what are the market prices of the bonds (you can assume annual interest payments).

b. The markets required return suddenly rises to 7%. What are the new bonds prices, and what is the percentage change in price for each bond?

c. If the markets required return falls from the initial 6% to 5%, what are the new prices, and what is the percentage change in each price relative to the answer obtained in part (a)?

d. Which bonds price is most sensitive to interest rate movements? Does this answer surprise you? Why or why not? Can you explain why this bonds price is so sensitive to rate changes?

e. Which bonds price is least sensitive to interest rate movements? Explain.

9. You purchase 1,000 shares of Spears Grinders stock for $50 per share. A year later, the shares pay a dividend of $1.20 per share and sell for $59.

a. Calculate your total dollar return.

b. Calculate your total percentage return.

c. Do the answers to parts (a) and (b) depend on whether you sell or continue to hold the shares after one year?

10. Nano-Motors has shares outstanding which sells for $10 per share. Macro-Motors shares cost $50 each. Neither share pays dividends at present.

a. An investor buys 100 shares of Nano-Motors. A year later each share sells for $15. Calculate the total return in dollar terms and in percentage terms.

b. Another investor buys 100 shares of Macro-Motors. A year later the share price has risen to $56. Calculate the total return in dollar terms and in percentage terms.

c. Why is it difficult to say which investor had a better year?

11. The cash flows associated with three different projects are as follows:

Cash Flows	Alpha ($ in millions)	Beta ($ in millions)	Gamma ($ in millions)
Initial Outflow	1.5	0.4	7.5
Year 1	0.3	0.1	2.0
Year 2	0.5	0.2	3.0
Year 3	0.5	0.2	2.0
Year 4	0.4	0.1	1.5
Year 5	0.3	0.2	5.5

a. Calculate the payback period of each investment.

b. Which investments does the company accept if the cut-off payback period is three years? Four years?

c. If the company invests by choosing projects with the shortest payback period, which project would it invest in?

11. Scotty Manufacturing is considering the replacement of one of its machine tools. Three alternative replacement tools A, B, and C are under consideration. The cash flows associated with each are shown in the following table. The firms cost of capital is 15%.

	A	B	C
Year	Cash Flows
0	$95,000	$50,000	$150,000
1	$20,000	$10,000	$58,000
2	20,000	12,000	35,000
3	20,000	13,000	23,000
4	20,000	15,000	23,000
5	20,000	17,000	23,000
6	20,000	21,000	35,000
7	20,000		46,000
8	20,000		58,000

a. Calculate the NPV of each alternative.

b. Using NPV, evaluate the acceptability of each tool.

c. Rank the tools from best to worst, using NPV.