Multiple-Choice Questions

1. What are the present values of the net tax shields for each option? a) $81,266 and $131,194 b) $339,330 and $394,356 c) $338,056 and $387,984 d) $336,579 and 380,599

2. What is the IRR for each option? Use the nearest tenth of a percent. a) 11.5% and 12.1% b) 12.0% and 13.0% c) 10.8% and 10.8% d) 11.2% and 11.3%

3. Which option has the highest NPV, and by how much over the other option? a) Option #2 - $53,161 b) Option #1 - $289,527 c) Option #1 - $739,537 d) Option #2 - $769.023

4. At what purchase price for Bink and Tashie's would the IRR equal the required rate of return? Use the nearest $10,000. a) $6,470,000 b) $6,560,000 c) $6,300,000

d) $6,380,000

5. What would the required rate of return have to be for Katherine to be indifferent between the two options? Use the nearest tenth of a percent. a) 11.1% b) 10.6% c) 11.2%

d) 10.3%

EXHIBIT #1
Bink and Tashie's Chocolate
Abbreviated Income Statement
For 2017
('000s of Dollars)
Sales		2,265
Cost of Goods Sold	1,430
Gross Margin		835
Overhead Salaries
Sales Salaries	300
Sales Bonus	100
Office Salaries	100
Owners' Salaries	200
Benefits	70
Total Overhead		770
Operating Profit		65
Taxes (30%)		20
Net Profit		45

EXHIBIT #2

Option #1 - Purchase Bink and Tashie's

Initial Costs

The $5.5 million purchase price consisted of the following:

1) $2 million for the building, which was its fair market value and would be used for CCA purposes

2) $500,000 for the land

3) $300,000 for the machinery, which was its fair market value and would be used for CCA purposes

4) $2.7 million for goodwill

In addition, for the purposes of this analysis, Katherine decided to include the severance packages for the salaried employees as requested by the owners of Bink and Tashie's. In terms of timing, she anticipated letting these people go immediately as she would simply absorb the work these people performed into the existing support functions of Katherine's Chocolate Kompany.

Yearly Cash Flow

In the first year (2018), Katherine anticipated sales being flat relative to the previous year and a cost of sales of 63%.

In the second through fifth year, sales were anticipated to grow 4% and then level off in years six through ten.

Cost of goods sold was anticipated to be 62% the second year and 59% from years three through ten.

Katherine anticipated $20,000 per year in overhead costs related to travel expenses for salespeople, etc.

Salvage Values

The machinery was expected to have a salvage value of $10,000 at the end of the tenth year.

There are no plans to sell the building.

Option #2 - Build Factory

Initial Costs

1) Purchase price of building - $2 million

2) Purchase price of machinery - $500,000

3) Purchase price of land - $500,000

Yearly Cash Flow

In the first year (2018), Katherine anticipated sales being $0.5 million and a cost of sales of 70%.

In the second year, Katherine anticipated sales being $0.7 million and a cost of sales of 65%.

In the third year, Katherine anticipated sales being $1.0 million and a cost of sales of 63%.

In the fourth year, Katherine anticipated sales being $1.2 million and a cost of sales of 60%.

In the fifth year, Katherine anticipated sales being $1.5 million and a cost of sales of 57%.

In the sixth through tenth year, Katherine anticipated sales being $1.8 million and a cost of sales of 57%.

In the first year, Katherine anticipated $60,000 in overhead costs related to travel expenses for salespeople and senior managers to establish the business. These costs were expected to be $30,000 in the second year and $20,000 from years three through ten.

Salvage Values

The machinery was expected to have a salvage value of $50,000 at the end of the tenth year.

There are no plans to sell the building.

Additional Information

CCA rates - Building 4%, Machinery 20%

Tax Rate for Bink and Tashie's - 30%

Tax Rate for Katherine's Chocolate Kompany - 40%

Required Rate of Return - 8%

Time horizon - 10 years