Question
The DEF Corporation is trying to decide whether to undertake an expansion of its production facilities. The expansion will cost $8.5 million, to be paid
The DEF Corporation is trying to decide whether to undertake an expansion of its production facilities. The expansion will cost $8.5 million, to be paid immediately. After tax cash flows generated by the expansion are projected to be $1 million next year, and will be growing indefinitely with inflation at 2.5% per year. Assume that the CAPM holds, the beta of DEF assets is 1.2, the riskless rate is 5% per year (and the yield curve is flat at this rate) and that the expected return on the market portfolio is 12%. Should DEF undertake the expansion? 5. You have developed the technology to use gold to produce high capacity fiber optic switches. The technology has cost $ 5 million to develop. You need $50 million of initial capital investment to start production. Sales of the switch sales will be $20 million per year for the next 5 years and then drop to zero. The main cost of production is gold. Each year, you need 20,000 ounces of gold. Gold is currently selling for $250 per ounce. Your supplier thinks that the gold price will appreciated at 5% per year for the next 5 years. The cost of capital is 10% for the fiberoptics business. The tax rate is 35%. The Halliburton is considering for a two-year project. The project requires an initial capital expenditure of $100 million (in year 0), which can be depreciated linearly to zero in the next two years. It generates a revenue of $80 million and a cost of $25 million per year for the next two years (year 1 and 2). The tax rate for Halliburton is 30%. (a) Compute the net after-tax cash flows of the project. (b) The cash flows of this project are risk-free. The market gives the following interest rates: Maturity (years) 1 2 3 Spot interest rate (%) 4.00 6.00 6.50 Should Halliburton take this project? Explain.
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