1. The Taylor Corporation is using a machine that originally cost $66,000. The machine has a book value of $66,000 and a current market value of $40,000. The asset is in the Class 5 CCA pool which allows 35% depreciation per year. It will have no salvage value after 5 years and the company tax rate is 40 percent. Jacqueline Elliott, the Chief Financial Officer of Taylor, is considering replacing this machine with a newer model costing $70,000. The new machine will cut operating costs by $10,000 each year for the next five years. Taylor’s cost of capital is 8 percent. Should the firm replace the asset? (Use NPV methodology to solve this problem).
a. Prepare a time scale showing the cash inflows and outflows for the entire period.
b. What is the total cash out flow in Year 0?
c. What would be the PV of the total cash inflows?
d. Calculate the PV of CCA Tax Shield
e. Calculate the NPV of the Project.
f. Should the company go ahead with the project or not
2. The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business computer system. The initial investment will be $35,000 and the hardware, which will be used for 10 years with a salvage value of $5,000, and software of $20,000. In each of years 3, 5, and 7, $5,000 will be spent for additional software. Hardware has a CCR rate 45 percent and software is class 12 (100 percent). The computer system is expected to provide additional revenue of $15,000 per year for the next ten years and to reduce expenses by $10,000 per year for the same period. The firm’s cost of capital is 12 percent and its tax rate is 40 percent. Based on a net present value analysis, should this investment be accepted?
a. Prepare a time scale showing the cash inflows and outflows for the entire period.
b. What is the total cash out flow in Year 0?
c. What would be the PV of the total cash inflows?
d. Calculate the PV of CCA Tax Shield
e. Calculate the NPV of the Project.
f. Should the company go ahead with the project or not
3. Suppose we are thinking about renovating a leased office. The renovations would cost $310,000. They would be depreciated on a straight line basis over the six year term of the lease. The new office would reduce heating and cooling costs by $30,000 per year. The manager also thinks that employees would be less likely to call in sick and be more productive. Also the new office would attract more customers. The combined employee productivity and increased sales is estimated to increase EBIT by $23,000 annually. The tax rate is 35% and the cost of capital for the company is 14.5%. Use NPV methodology to determine if the project should go ahead or not.
a. Prepare a time scale showing the cash inflows and outflows for the entire period.
b. What is the total cash out flow in Year 0?
c. What would be the PV of the total cash inflows?
d. Calculate the PV of CCA Tax Shield
e. Calculate the NPV of the Project.
f. Should the company go ahead with the project or not?
4. A new modular paver has been introduced into the market. The technology is so innovative that it makes all previous pavers obsolete. Standard Construction had just purchased a new paver last year for $550,000. It was worth $470,000 on the market, but the new technology paver has reduced the market value to $55,000 today. If the company keeps the new paver for 10 years as planned, the salvage value of the paver would be $5,000. The new excavator costs $650,000 and would increase revenues by $80,000 per year. The new excavator has a 10 year life and an expected salvage value of $135,000. The company’s tax rate is 35% and the CCA rate for this type of industrial machinery is 20%. Depreciation is calculated using the declining balance. The company expected rate of return is 13%. Should the company get rid of the current paver and buy the new technology one. Use NPV methodology to determine what the company should do.
a. Prepare a time scale showing the cash inflows and outflows for the entire period.
b. What is the total cash out flow in Year 0?
c. What would be the PV of the total cash inflows?
d. Calculate the PV of CCA Tax Shield
e. Calculate the NPV of the Project.
f. Should the company go ahead with the project or not?
5. Dairy Corp. has a $15 million bond obligation outstanding which it is considering refunding. The bonds were issued at 11.5% and the interest rates on similar bonds have declined to 8%. The bonds have twelve years of their 20 year maturity remaining. Dairy will pay a call premium of 5% and will incur underwriting costs of $350,000 immediately. There is no underwriting cost consideration on the old bond. The company is in a 40% tax bracket. There is no overlap interest period. Should the old issue be refunded?
6. Top-Down, Inc. finances its operations maintaining a debt to equity ratio of 0.6. They have just issued $1,000,000 of 6% bonds that are trading at 101.7. The bond will mature in 5 years. Brokers are rating Top-Down’s common shares as moderately risky with a Beta of 1.15, with a market risk premium of 7.75%. Market conditions are good and interest rates rate have hit historic lows with Canada Savings bonds currently paying 2.25%. The tax rate for Top Down is 34 percent. The flotation costs are 3 percent for debt, 6 percent for preferred stock, and 8 percent for common stock. Currently, the firm is considering a small project that it considers to be equally as risky as the overall firm. The project has an initial cash outlay of $18,500 and is expected to have a single cash inflow of $25,000 at the end of year two.
a. What is the weight of Debt?
b. What is the weight of Equity?
c. What is the cost of Debt?
d. What is the cost of Equity?
e. Calculate the WACC of Top-Down?
f. Calculate the weighted average Flotation Costs for Top-Down?
g. What would be the total amount that Top-Down would have to raise including flotation costs?
h. Calculate the NPV for the project?
7. A&B Enterprises is trying to select the best investment from among four alternatives. Each alternative involves an initial outlay of $87,900. Their cash flows follow:
Year | A | B | C | D |
1 | $10,000 | $50,000 | $25,000 | $ 0 |
2 | 20,000 | 40,000 | 25,000 | 0 |
3 | 30,000 | 30,000 | 25,000 | 45,000 |
4 | 40,000 | 0 | 25,000 | 55,000 |
5 | 50,000 | 0 | 5,000 | 60,000 |
Evaluate and rank each alternative based on a) payback period, b) net present value (use a 13% discount rate), and c) internal rate of return.
8. The Intelligent Computing Co. is trying to choose between two mutually exclusive projects:
Year | Cash Flow “A” | Cash Flow “B” |
0 | -49,500 | -22,500 |
1 | 15,500 | 7,000 |
2 | 15,500 | 7,000 |
3 | 15,500 | 7,000 |
4 | 15,500 | 7,000 |
a. If the required return is 10% and the company applies the profitability index decision rule, which project should the firm accept?
b. If the company applies the NPV decision rule, which project should it take?
c. Which decision rule would you choose? Explain.
9. You are considering two mutually exclusive projects with the following cash flows. Which project(s) should you accept if the discount rate is 7.75 percent? What if the discount rate is 11 percent?
Year | Project A | Project B |
0 | -$300,000 | -$197,000 |
1 | 2000 | 120,000 |
2 | 2000 | 91,000 |
3 | 3000 | 37,000 |
4 | 460,000 | 0 |
10. Hartley, Inc. needs to purchase equipment for its 2,000 drive-ins nationwide. The total cost of the equipment is $2 million. It is estimated that the after-tax cash inflows from the project will be $210,000 annually in perpetuity. Hartley has a market value debt-to-assets ratio of 40%. The firm’s cost of equity is 13%, its pre-tax cost of debt is 8%, and the flotation costs of debt and equity are 2% and 8%, respectively. The tax rate is 34%. Assume the project is of similar risk to the firm’s existing operations.
a. What is Hartley’s weighted average cost of capital? )
b. Ignoring flotation costs, what is the NPV of the proposed project?
c. What is the weighted average flotation cost for Hartley?
d. What is the dollar flotation cost for the proposed financing?
e. After considering flotation costs, what is the NPV of the proposed project?