I need help in completing the remaining problems

9-8

10-1 thru 10-6

and CHECK Accuracy of 11-4 & 11-6

Thank you

9-2 LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL's after-tax cost of debt? Initial Investment Outlay (Capital Expenditure for new equipment) + (Initial investment in working Capital) Initial Investment Outlay = $12,000,000+ 5,000,000 Initial Investment Outlay= $17,000,000 Research expense incurred in last year related to this project is a sunk cost. It will not be considered while evaluating project at current moment. The answer will not change. In this case sale value of building after tax represents opportunity cost. That means we are losing opportunity of $ 1.5 million if equipment installed in own building, Hence this will be considered. Project Cost= $18,500,000 ( $17,000,000 + $ 1,500,000) 9-5 Summerdahl Resort's common stock is currently trading at $36 a share. The stock is expected to pay a dividend of $3.00 a share at the end of the year (D1 = $3.00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity? Solution:- Computation of the Cost of Common Equity The formula for calculating cost of equity is Ke = (D1 / P0) + g Where D1 = $3 P0 = $36 g = 5% Ke = ($3 / $36) + 0.05 = 0.133 or 13.3% the cost of equity is 13.3% 9-6 Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%, and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 15%. What is the estimated cost of common equity using the CAPM? Solution: - Computation of the Cost of Common Equity using the CAPM Stock Beta = 0.8 Yield on a 3 month T-bill is 4% Risk-free Rate (Rf) = 4% Yield on a 10 year T-bond = 6% Market Risk-premium (MRP) = 5.5% Rate of Return on a Average Stock in the market last year was = 15% Calculating Estimated Cost of Common Equity using CAPM: According to CAPM: RE = Rf + * MRP RE = 4% + 0.8 * 5.5% RE = 0.04 + (0.8 * 0.055) RE = 0.04 + 0.044 RE = 0.084 (or) 8.4% Estimated Cost of Common Equity ( RE ) = 8.4% Hence the Cost of Equity is 8.4% under CAPM 9-8 David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.96%. What is the company's cost of equity capital? 10-1 A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the project's NPV? (Hint: Begin by constructing a time line.) (10-2) Refer to Problem 10-1. What is the project's IRR? (10-3) Refer to Problem 10-1. What is the project's MIRR? Refer to Problem 10-1. What is the project's PI? (10-5) Refer to Problem 10-1. What is the project's payback period? (10-6) Refer to Problem 10-1. What is the project's discounted payback period? 10-8 Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year's capital budget. The projects are independent. The cash outlay for the truck is $17,100 and that for the pulley system is $22,430. The firm's cost of capital is 14%. After-tax cash flows, including depreciation, are as follows: Year 1 2 3 4 5 Truck $5,100 5,100 5,100 5,100 5,100 Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept-reject decision for each Solution for truck (all figures in $$) PV of Cash inflows Less: Outflows NPV: Computation of IRR: Cost of capital 14% Cost of capital 15% Let IRR be r%- (r-14)/15-14) Computation of MIRR FV of positive cash flow MIRR For Pulley (all figures in $$) Pulley $7,500 7,500 7,500 7,500 7,500 PV of cash inflows Less: outflows NPV IRR Since at 20% PV of cash inflows is within 1% of cash outflow IRR= 20% Computation of MIRR FV of positive cash flow MIRR Year cash inflow 1 2 3 4 5 5100 5100 5100 5100 5100 discounting factor at 14% PV @ 14% PV @ 15% 0.877192982 4473.684 4434.783 0.769467528 3924.284 3856.333 0.674971516 3442.355 3353.333 0.592080277 3019.609 2915.942 0.519368664 2648.78 2535.601 17508.71 17100 408.7129 PV of cash PV of cash 17095.99 17508.71 17095.99 (17100-17508.71)/(17095.99-17508.71 r= 14.99028644 33711.53122 0.404077838 Year cash inflow 1 2 3 4 5 7500 7500 7500 7500 7500 40.41% Discounting factor at 14% PV @ 14% PV @ 18% 0.877192982 6578.947 6355.932 0.769467528 5771.006 5386.383 0.674971516 5062.286 4564.732 0.592080277 4440.602 3868.417 0.519368664 3895.265 3278.319 PV @ 20% 6250 5208.333 4340.278 3616.898 3014.082 25748.11 22430 3318.107 49575.7812 0.70269448 70.27% 23453.78 22429.59 11-1 Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 40%. a. What is the initial investment outlay? b. The company spent and expensed $150,000 on research related to the new product last year. Would this change your answer? Explain. c. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer? A. B. C. In Million Solution Cost of manufacturing unit Working Capital Investment $17 $5 Initial investment outlay $22 No, the answer or the figure will be the same. The costs which are incurred for research is known as Sunk Cost and Sunk Costs never affect the decisions. In this case Sunk Cost has already been incurred and benefits will be reaped in future. In this case as it is an Opportunity Cost, Thus by selling a building at $1.5 million and using the money in the business will save cost. But the earning more or similar.So utilising the money and vacant building will save the cash flow of business. 11-2 The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service: Projected sales $18 million Operating costs (not including depreciation) $ 9 million Depreciation $ 4 million Interest expense $ 3 million The company faces a 40% tax rate. What is the project's operating cash flow for the first year (t = 1)? A Particulars Sales Less: Operating Cost Less: Depreciation Earnings before Intrest and tax Less: Tax @ 40% on EBIT Net Income before intrest Add: Depreciation Operating Cash flow The project's operating cash flow for the first year (t = 1) B Amount ( in Millions) $18 $9 $4 $5 $2 $3 $4 $7 $7,000,000.00 11-3 Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $12 million, of which 75% has been depreciated. The used equipment can be sold today for $4 million, and its tax rate is 40%. What is the equipment's after-tax net salvage value? Solution Calculation of Book Value Book Value = Equipment Cost x Depreciation = $12, 000,000.00 x (1-75%) = $3,000,000.00 = The Book value Calculation of the gain on sale = $4,000,000.00 - $3,000,000.00 = $1,000,000.00 = The gain on sale. Calculation After tax net salvage value = Sale value - ( gain on sale x tax rate) = $4,000,000.00 - ($1,000,000.00 x 40%) = $3,600,000.00 = Net tax salvage value 11-4 Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The firm's WACC is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine? 11-6 The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%. a. What is the Year 0 net cash flow? b. What are the net operating cash flows in Years 1, 2, and 3? c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of working capital)? d. If the project's cost of capital is 12%, should the machine be purchased 23-1 Zhao Automotive issues fixed-rate debt at a rate of 7.00%. Zhao agrees to an interest rate swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao's resulting net payment? Solution Conversion Fixed Rate Debt LIBOR rate 7% 6.80% Net Fixed payment Fixed intrest payment - Fixed interest payment received 7% - 6.8% = 0.20% Zhao Net Payment LIBOR + 0.20% 23-2 A Treasury bond futures contract has a settlement price of 89'08. What is the implied annual yield? Solution Treasury bond Futures Has a settlement price Contract settlement Price Face/Future value of treasury bond 89-08 08/32 89.25 $100 Calculation of Annual yeild of Treasury Bond Number of periods 1 Present Value of Treasury Bonds 89.25 Future Value of Treasury Bonds -100 Annual yeild of Treasury Bond 0.12044 or 12.04% 89 + 0.25