Question 12 (20 points) Go to Problem 12-8 on page 439. And answer the following questions. What is the year zero project cash flow? STATE

Question 12 (20 points)

Go to Problem 12-8 on page 439. And answer the following questions. What is the year zero project cash flow? STATE YOUR ANSWER WITH A NEGATIVE SIGN. DO NOT USE COMMAS OR DECIMAL PLACES.

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What are the project cash flows in Years 1, 2 and 3? ROUND YOUR ANSWER TO THE NEAREST WHOLE DOLLAR. DO NOT USE COMMAS OR DECIMAL PLACES.

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Given a WACC of 9%, what is the net present value of the project? ROUND UP TO THE NEAREST WHOLE DOLLAR. DO NOT USE DECIMAL PLACES OR COMMAS.

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Chapter 12 Cash Flow Estimation and Risk Analysis 439 12-5 Size IRR A B UU OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects: Project $ 650,000 14.0% 1,050,000 13.5 1,000,000 11.2 1,200,000 11.0 500,000 10.7 650,000 10.3 700,000 10.2 Assume that each of these projects is independent and that each is just as risky as the firm's existing assets. Which set of projects should be accepted, and what is the firm's optimal capital budget? 12-6 DEPRECIATION METHODS Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33%, 45%, 15%, and 7%, as discussed in Appendix 12A. The company's WACC is 8%, and its tax rate is 35%. a. What would the depreciation expense be each year under each method? b. Which depreciation method would produce the higher NPV, and how much higher would it be? 12-7 SCENARIO ANALYSIS Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be "average." However, the CFO realizes that conditions could be better or worse, so she performed a scenario analysis and obtained these results: Intermediate Problems 6-12 Economic Scenario Probability of Outcome NPV Below average 12-8 Recession 0.05 ($70 million) 0.20 (25 million) Average 0.50 12 million Above average 0.20 20 million Boom 0.05 30 million Calculate the project's expected NPV, standard deviation, and coefficient of variation. NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $60,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%, as discussed in Appendix 12A. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm's marginal federal-plus-slate tax rate is 35%. a. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? b. What are the project's annual cash flows in Years 1, 2, and 3? c. If the WACC is 9%, should the spectrometer be purchased? Explain. Chapter 12 Cash Flow Estimation and Risk Analysis 439 12-5 Size IRR A B UU OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects: Project $ 650,000 14.0% 1,050,000 13.5 1,000,000 11.2 1,200,000 11.0 500,000 10.7 650,000 10.3 700,000 10.2 Assume that each of these projects is independent and that each is just as risky as the firm's existing assets. Which set of projects should be accepted, and what is the firm's optimal capital budget? 12-6 DEPRECIATION METHODS Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33%, 45%, 15%, and 7%, as discussed in Appendix 12A. The company's WACC is 8%, and its tax rate is 35%. a. What would the depreciation expense be each year under each method? b. Which depreciation method would produce the higher NPV, and how much higher would it be? 12-7 SCENARIO ANALYSIS Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be "average." However, the CFO realizes that conditions could be better or worse, so she performed a scenario analysis and obtained these results: Intermediate Problems 6-12 Economic Scenario Probability of Outcome NPV Below average 12-8 Recession 0.05 ($70 million) 0.20 (25 million) Average 0.50 12 million Above average 0.20 20 million Boom 0.05 30 million Calculate the project's expected NPV, standard deviation, and coefficient of variation. NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $60,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%, as discussed in Appendix 12A. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm's marginal federal-plus-slate tax rate is 35%. a. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? b. What are the project's annual cash flows in Years 1, 2, and 3? c. If the WACC is 9%, should the spectrometer be purchased? Explain