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FNCE 370v9: Assignment 3 Assignment 3 is worth 5% of your final mark. Complete and submit Assignment 3 after you complete Lesson 9. Questio n 1 2 3 4 5 6 7 8 9 Total Marks available 12 3 13 10 13 9 9 17 14 100 Marks awarded Referenc e Lesson 7 Lesson 7 Lesson 7 Lesson 8 Lesson 8 Lesson 8 Lesson 9 Lesson 9 Lesson 9 Note on Decimal Places When working through numerical problems, use as many decimal places as shown on your financial calculator. Do not round your calculated answers until you have reached the final answer. When you reach your final answer, round as follows, unless the question specifies otherwise. Percentages: round to two decimal places Dollars: round to two decimal places Others: round to four decimal places Questions 1. Choo Choo Inc. is a manufacturer of model trains. The company is considering the purchase of an industrial 3D printer, which will allow the firm to produce custommade model trains for its high-end customers. The printer will cost $1,000,000, and it is expected to produce net cash flows of $350,000 per year for the next six years. Liquidation of the equipment will net the firm $100,000 in cash at the end of six years. The firm requires a 13% rate of return on all investments. Ignore the effects of taxes. (12 marks total) a. What is the payback period for the proposed investment in the 3D printer? Provide your answer in number of years and months. (1 mark) b. What is the printer's discounted payback period? Provide your answer in number of years and months. (2 marks) c. Choo Choo's cutoff period is set at three years. Based on the payback period investment criterion, will the company purchase the printer? Will it purchase the printer based on the discounted payback period investment criterion? (1 mark) FNCE 370v9 1 June 22, 2017 d. What is the printer's net present value (NPV)? Should the company purchase the printer based on the NPV investment criterion? (2.5 marks) e. What is the printer's profitability index (PI)? Should the company purchase the printer based on the PI investment criterion? (1.5 marks) f. What is the printer's internal rate of return (IRR)? (2 marks) g. Check that at the internal rate of return (IRR) the net present value of the printer is $0. Should the company purchase the printer based on the IRR investment criterion? (1.5 marks) h. Based on your answers in parts a-f above, what decision do you recommend for Choo Choo? (0.5 mark) 2. Given the following information and ignoring taxes, what is the annual cash revenue that will make the net present value equal to zero (i.e., the annual cash revenue that will cause us to break-even in the financial sense)? (3 marks) 3. Annual cash costs = $14,000 Life of project = 8 years Initial cost of project = $30,000 Salvage value at end of project = $2,000 Required rate of return = 15% We have two mutually exclusive investments with the following cash flows: (13 marks total) Year 0 1 2 3 4 Investment A -$100 50 40 40 30 Investment B -$100 20 40 50 60 a. Using a financial calculator, calculate the IRR for each of the investments. (1 mark) b. Based on the IRR rule and a required return of 15%, which investment should we choose? (1 mark) c. Calculate the NPV profile for each investment, using the discount rates of 0%, 5%, 10%, 15%, 20%, and 25%. Perform this task in an Excel spreadsheet. Cautionary note: If you use the =NPV() function in Excel to calculate the NPVs, it will provide incorrect answers. The NPV() function actually calculates the present value of all cash inflows. The NPV should be calculated as =NPV(all cash inflows) - initial cash outflow. (2 marks) FNCE 370v9 2 June 22, 2017 d. Plot the NPV profile for both projects using the X-Y scatter function in Excel. (2 marks) e. If the required return on this project is 16%, would both NPV and IRR give us the same conclusion? Explain your answer. (2.5 marks) f. If the required return on this project is 9%, would both NPV and IRR give us the same conclusion? Explain your answer. (2.5 marks) h. Calculate the crossover rate at which we are indifferent between the two investments. (2 marks) 4. A proposed cost-saving project requires a device with an installed cost of $540,000. The project will last for five years. The device has a CCA rate of 20%. The required initial net working capital investment is $20,000, the marginal tax rate is 37%, and the required return on the project is 11%. The device has an estimated salvage value of $95,000 at the end of Year 5, and the net working capital investment will also be recovered at the end of Year 5. What level of pre-tax cost savings do we require for this project to be profitable? (10 marks) 5. We have two independent and mutually exclusive projects, A and B. Project A requires an initial investment of $1000, and will yield $500 of cash inflows for the next three years. Project B requires an initial investment of $3,500, and will yield $1,000 of cash inflows for the next five years. The required return on both projects is 10%. (13 marks total) a. What are the net present values of Project A and Project B? (2 marks) b. What is the problem with using the NPV investment criterion in this case? What alternative criterion should be used? (1 mark) c. Which project should be chosen? (2 marks) The cash flows and required return given are all in nominal terms. Given that the inflation rate is 3%, answer the following questions: d. What is the real rate of return based on the exact Fisher equation? e. What are the real cash flows from Project A and Project B? f. (1 mark) (2 marks) What are the real net present values of Project A and Project B? (Hint: The real NPV should be the same as the nominal NPV.) (2 marks) g. Which project should be chosen based on the real cash flows and real rate of return? (3 marks) 6. A new printing machine costs $19,000 and has an installation cost of $1,000. It belongs to CCA Class 8, which means that it has a CCA rate of 20%. The manufacturer of this machine guarantees that this machine will last for five years. Assume a tax rate of 40%. (9 marks total) FNCE 370v9 3 June 22, 2017 a. In the table provided, fill in the beginning undepreciated cost of capital (Beg UCC), the capital cost allowance (CCA), the ending undepreciated cost of capital (End UCC), and the CCA tax shield (CCATS) for each of the next five years. Remember to use the half-year rule. (2.5 marks) Year 1 2 3 4 5 Beg UCC CCA End UCC CCATS b. Assuming a required return of 12%, calculate the present value of CCATS (PVCCATS) for each of the five years, using the numbers calculated in part (a). (2 marks) c. Based on the numbers calculated in part (b) above, what is the total PVCCATS over the five years? (0.5 mark) d. Assume that salvage value at the end of Year 5 is $1,000. What is the total PVCCATS if we use the long formula? (2 marks) PVCCATS = C0 dT 1+0 . 5 k SdT 1 (d +k ) 1+k ( d+ k ) (1+k )N [ [ e. What is the reason for the difference between your answers in parts (c) and (d)? (2 marks) 7. For the following questions, assume no taxes and straight-line depreciation. (9 points total) a. What is the cash break-even quantity, and how is it calculated? Use both words and an equation in your explanation. Include a discussion of payback period, NPV, and IRR at the cash break-even sales level. (3 marks) b. What is the accounting break-even quantity, and how is it calculated? Use both words and an equation in your explanation. Include a discussion of payback period, NPV, and IRR at the accounting break-even sales level. (3 marks) c. What is the financial break-even quantity, and how is it calculated? Explain using both words and an equation. Make sure that you discuss the two steps involved in finding the financial break-even point. Also, include a discussion of discounted payback period, NPV, and IRR at the financial break-even sales level. (3 marks) FNCE 370v9 4 June 22, 2017 8. You are considering a new product launch. The project will cost $680,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year, price per unit will be $19,000, variable cost per unit will be $14,000, and fixed costs will be $150,000 per year. The required return on the project is 15%, and the relevant tax rate is 35%. (17 marks total) a. Based on your experience, the unit sales, variable cost, and fixed cost projections given here are probably accurate to within 10%. What are the upper and lower bounds for these projections for unit sales, variable cost, and fixed cost? (3 marks) b. What is the base-case NPV? (1 mark) c. What are the NPVs in the best-case and worst-case scenarios? (2 marks) d. Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (2.5 marks) e. What is this project's cash break-even level of output (ignoring taxes)? (1 mark) f. What is the accounting break-even level of output for this project, and what is the degree of operating leverage (DOL) at the accounting break-even point? How do you interpret this DOL number? (2.5 marks) g. What is the financial break-even level of output for this project, and what is the degree of operating leverage (DOL) at the financial break-even point? How do you interpret this DOL number? (5 marks) 9. You are considering a project that will supply an automobile production facility with 35,000 tonnes of machine screws annually for five years. To get the project started, you will need an initial $1,500,000 investment in threading equipment. The project will last for five years. The accounting department estimates that annual fixed costs will be $300,000 and that variable costs should be $200 per tonne. The CCA rate for treading equipment is 20%. Accounting estimates a salvage value of $500,000 after costs of dismantling. The marketing department estimates that the auto makers will accept the contract at a selling price of $230 per tonne. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 13% return and face a marginal tax rate of 38% on this project. (14 marks total) a. What is the NPV for this project? Should you pursue this project? (5 marks) b. Suppose you believe that the accounting department's initial cost and salvage projections are accurate only to within 15%; the marketing department's price estimate is accurate only to within 10%; and the engineering department's net working capital estimate is accurate only to within 5%. What is your worst-case scenario for this project? Your best-case scenario? (9 marks) FNCE 370v9 5 June 22, 2017