DUKE UNIVERSITY Fuqua School of Business. FINANCE CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2.


 Gordon Arnold
 3 years ago
 Views:
Transcription
1 DUKE UNIVERSITY Fuqua School of Business FINANCE CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Two years ago, you put $20,000 dollars in a savings account earning an annual interest rate of 8%. At the time, you thought that these savings would grow enough for you to buy a new car five years later (i.e., in three years from now). However, you just reestimated the price that you will have to pay for the new car in three years at $36,000. (a) How much more money do you need to put in your savings account now for it to grow to this new estimate in three years? (b) Now suppose that you know that the car company will offer you to pay for the car over some time. In particular, you will have the opportunity to make a downpayment of $12,000 at the time you get the car (three years from now) and to make additional payments of $13,000 at the end of each of the following two years. With this offer, how much money do you need to add to your account now? 2. A rich entrepreneur would like to set up a foundation that will pay a scholarship to one deserving student every year. The first such scholarship will pay $5,000 (in nominal terms) and is to be awarded in three years from now. A scholarship will be awarded in perpetuity every year after that (even after the entrepreneur s death), but will be indexed at 2% a year to account for inflation. How much money should the entrepreneur put in the foundation s account, if that account earns 10% a year? 3. Your parents make you the following offer. They will give you $10,000 at the end of every year for the next five years if you agree to pay them back $10,000 at the end of every year for the following ten years. Should you accept this offer if your opportunity cost (discount rate) is 12% a year? 4. You have a firm that starts out with $60,000 in cash in the bank. You have three investment opportunities: (1) You can invest $30,000 today and get back a gross payoff of $45,000 next year; (2) you can invest $20,000 today and get back a payoff of $24,000 next year; (3) you can invest $10,000 today and get back a payoff of $20,000 next year. You can undertake any or all of these investment opportunities. (a) Suppose the interest rate is 30%. What investment policy do you undertake, and what is the value of your firm today after you announce your investment policy? (b) Suppose you want to consume $30,000 today and the rest next year. How much money do you need to borrow or lend? How much can you consume tomorrow? (c) Suppose a fourth investment opportunity (4) is added to the problem: invest $15,000 today and get back $50,000 next year. In which projects should you invest? 1
2 5. In the following figure, the sloping straight line represents the opportunities for investment in the capital market, and the solid curved line represents the opportunities for investment in plant and machinery (real assets). The company s only asset at present is $2.6 million in cash. $ tomorrow Owner's preferred consumption patttern $ today (a) What is the interest rate? (b) How much should the company invest in plant and machinery? (c) How much will this investment be worth next year? (d) What is the average rate of return on the investment? (e) What is the marginal rate of return? (f) What is the present value of this investment? (g) What is the net present value of this investment? (h) What is the total present value of the company? (i) How much will the individual consume today? (j) How much will he consume tomorrow? (k) Is he a borrower or a lender? 6. Draw a figure (like the ones we drew for Mr. Rossi in the course s first lecture) to represent the following situation. A firm starts out with $10 million in cash. The rate of interest r is 10%. To maximize net present value, the firm invests today $6 million in real assets. This leaves $4 million which can be paid out to shareholders. The net present value of the investment is $2 million. When you have finished, answer the following questions. (a) How much cash is the firm going to receive in year 1 from its investment? (b) What is the marginal return from the firm s investment? 2
3 (c) What is shareholders wealth (today) after the firm has announced its investment plan? (d) What is the present value of the projects cash flows? (e) Suppose shareholders want to spend $6 million today. How can they do this? (f) How much will they then have to spend next year? 7. Sonos is in the process of assessing the attractiveness of a new project. The project has an estimated life of three years. The project s revenue estimates are as follows: Sales = 50,000 units/year. Per unit price: $100 in year 1, $110 in year 2, $130 in year 3. The project s cost estimates are as follows: Upfront for new equipment = $2,400,000. Annual overhead = $1,300,000. Per unit cost = $50. The expected life of the new equipment is 4 years, and it will be depreciated straightline over that time. Because the project will be over by the end of year 3 however, Sonos plans to resell this equipment for $800,000 at the end of year 3. In terms of net working capital, the following assumptions have been agreed upon: The project will have no cash or inventory requirement (i.e., manufactured products are shipped directly to customers). Payables are expected to be 10% of annual COGS (as Sonos may purchase some of the products necessary for production on credit). Receivables are expected to be 10% of annual sales (as customers may take some time to pay for the goods, and so not all cash flows are received by year end). Net working capital will fall back to zero in year 4 (i.e., all outstanding payments from customers are received, and all outstanding bills are paid that year). What is the net present value of this project if the corporate tax rate is 35% and the cost of capital (i.e., discount rate) is 16%? 8. The firm Nalyd is considering an investment in equipment to produce a new product. The cost of the equipment is $150,000. This equipment falls into the 5year asset class and thus would have to be capitalized and depreciated over 6 years at rates 20%, 32%, 19.2%, 11.52%, 11.52%, and 5.76%. Nalyd expects to use the equipment for three years and then to sell it for $60,000. For the three years of operation, the equipment will generate revenues of $40,000 per year and will have operating costs of $3,000 per year. If the opportunity cost of capital for Nalyd is 12% and its tax rate is 35%, should Nalyd purchase this equipment? For simplicity, assume that net working capital stays at zero throughout the project s life. Also, assume that Nalyd s other projects are and will remain profitable, so that any negative tax on this one project can be considered a positive cash flow. 3
4 (Difficult) 9. Conocococonut is considering the purchase of a new harvester. They are currently involved in deliberations with the manufacturer and as of yet the parties have not come to a settlement regarding the final purchase price. The management of Conocococonut has hired you, a highpriced consultant, to establish the maximum price it should be willing to pay for the harvester (i.e., the breakeven price such that the NPV of the project would be zero). This will be of obvious use to Conocococonut in their haggling with the capital equipment manufacturer. You are given the following facts: The new harvester would replace an existing one that has a current market value of $20,000. The new harvester is not expected to affect revenues, but beforetax operating costs will be reduced by $10,000 per year for ten years. The old harvester is now five years old. It is expected to last for another ten years and to have a resale value of $1,000 at the end of those ten years. The old harvester was purchased for $50,000 and is being depreciated to zero on a straightline basis over ten years. The new harvester will be depreciated straightline over its 10 year life to a zero book value. Conocococonut expects to be able to sell the harvester for $5,000 at the end of the ten years. The corporate tax rate is 34% and the firm s cost of capital is 15%. For simplicity, assume that net working capital stays at zero throughout. Also, if you solve this problem using a spreadsheet feel free to assume that annual revenues are $50,000 (for both harvesters) and that annual costs are $20,000 ($10,000) for the old (new) harvester. (Optional) 10. (Minicase, taken from Ross, Westerfield and Jaffe, 6th edition) After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire, the SuperTread, and must decide whether to make the investment necessary to produce and market the SuperTread. Thetirewouldbeideal fordriversdoingalarge amount ofwet weather andoffroad driving in addition to its normal freeway usage. The research and development costs so far total about $10 million. The SuperTread would be put on the market beginning this year and Goodweek expects it to stay on the market for a total of four years. Test marketing costing $5 million shows that there is a significant market for a SuperTreadtype tire. As a financial analyst at Goodweek Tires, you are asked by your CFO, Mr. Adam Smith, to evaluate the SuperTread project and provide a recommendation on whether to go ahead with the investment. You are informed that all previous investments in the SuperTread are sunk costs and only future cash flows should be considered. Except for the initial investment (in production equipment and working capital) which will occur immediately, assume all cash flows will occur at yearend. Goodweek must initially invest $120 million in production equipment to make the SuperTread. The equipment is expected to have a sevenyear useful life. This equipment can be sold for $51,428,571 at the end of four years. Goodweek intends to sell the SuperTread to two distinct markets: 4
5 (a) The Original Equipment Manufacturer (OEM) Market. The OEM market consists primarily of the large automobile companies (e.g., General Motors) who buy tires for new cars. In the OEM market, the SuperTread is expected to sell for $36 per tire. The variable cost to produce each tire is $18. (b) The Replacement Market. The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins and Goodweek expects to sell the SuperTread for $59 per tire there. Variable costs are the same as in the OEM market. Goodweek Tires intends to raise prices at 1 percent above the inflation rate. 1 Variable costs will also increase 1 percent above the inflation rate. In addition, the SuperTread project will incur $25 million in marketing and general administration costs the first year (this figure is expected to increase at the inflation rate in the subsequent years). Goodweek s corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 3.25 percent. The company uses a 15.9 percent discount rate to evaluate new product decisions. Automotive industry analysts expect automobile manufacturers to produce 2 million new cars this year and production to grow at 2.5 percent per year thereafter. Each new car needs four tires (the spare tires are undersized and are in a different category). Goodweek Tires expects the SuperTread to capture 11 percent of the OEM market. Industry analysts estimate that the replacement tire market size will be 14 million tires this year and that it will grow at 2 percent annually. Goodweek expects the SuperTread to capture an 8 percent market share. You decide to use the MACRS depreciation schedule (sevenyear property class), which is as follows. Year Depreciation % 14.29% 24.49% 17.49% 12.49% 8.93% 8.93% 8.93% 4.45% You also decide to consider net working capital (NWC) requirements in this scenario. The immediate initial working capital requirement is $11 million, and thereafter the net working capital requirements will be 15 percent of sales. What will be the NPV and IRR on this project? Note: You should use a spreadsheet to solve this problem. 1 Feel free to use g = i + 1% or g = (1 + i)(1.01) 1, where i is the inflation rate. I will use the latter in my solution. 5
6 Solutions 1. (a) Let us first figure out how much money (FV) is now in the account ,000 (1.08) 2 FV FV = 20,000(1.08) 2 = 23, Now, the account should have an amount PV in it for it to grow to $36,000 in three years PV PV = 36,000 (1.08) 3 = 28, (1.08) 3 36,000 So, you need to put $28, $23, = $5, in the account. (b) The present value (at time 0) of these three payments is PV = 12,000 (1.08) ,000 (1.08) ,000 (1.08) 5 = 27, So, you need to add $27, $23, = $4, to the account. 2. First, let us calculate how much money will need to be in the account at the end of the second year; let us denote that amount by PV ,000 5,000(1.02) 5,000(1.02) 2 PV = 5, For the account to be worth this much in two years, the amount that the entrepreneur needs to contribute initially is PV = PV 3. The present value of what you get is given by ( 1 PV + = 10, (1.10) 2 = 5, (1.10) 2 = 51, (1.12) 5 ) = 36, The present value of what you will have to pay back is given by PV = 10,000 ( ) (1.12) 10 (1.12) 5 = 32, Since the present value of the money you will get is larger than that you will have to pay back (PV + > PV ), you should accept the offer. 6
7 4. (a) Compute the rate of returns on the three projects: r 1 = 45,000 30,000 30,000 r 2 = 24,000 20,000 20,000 r 3 = 20,000 10,000 10,000 = 50% > 30%, = 20% < 30%, = 100% > 30%. You should therefore invest in (1) and (3) and have $20,000 for today s consumption. The projects NPVs are NPV 1 = 30, , = 4,615, NPV 2 = 20, , = 1,538, NPV 3 = 10, , = 5,385, After your announcement of the selection of projects (1) and (3) (before consumption), the firm should be worth 60,000+NPV 1 +NPV 3 = 70,000. In other words, this is how much you can sell the firm for at the time. (b) From the answer to part (a), you need to borrow an extra 30,000 20,000 = 10,000 in order to achieve the consumption goal of $30,000 today. (You should not forego any of the positive NPV projects, instead you can make use of the capital market to adjust your consumption.) Tomorrow s consumption level is 45,000+20,000 (10, ) = 52,000. (c) Also invest in project (4), in addition to projects 1 and 3: r 4 = 50,000 15,000 15,000 = %. 5. (a) = 25%. (b) $2.6 million $1.6 million = $1.0 million. (c) $3 million. (d) = 200%. (e) 25%. (f) $4 million $1.6 million = $2.4 million. (g) $2.4 million $1 million = $4 million $2.6 million = $1.4 million. (h) $4 million. (i) $1 million. 7
8 (j) $3.75 million. (k) He is a lender (since he consumes less than $1.6 million today). 6. The following figure shows the solution to the first part of the question. $million period Real investment opportunities Real investment NPV $million period 0 Here is how the numbers in that figure are calculated: (a) (1.1) = $8.8 millions. 4 = 10 6; 11 = 10(1+r) = 10(1.1); 12 = 10+NPV = 10+2; 13.2 = 12(1+r) = 12(1.1); 8.8 = (12 4)(1+r) = 8(1.1). (b) The firm will invest (in real assets) until its marginal rate of return (from these assets) is equal to the interest rate, i.e. the marginal return is 10%. (c) 10+NPV = $12 millions. (d) The net present value is NPV = PV(future cash flow from projects) I. We know that I = 6, and we know that NPV = 2. This implies that PV(future cash flow from projects) = NPV +I = 2+6 = 8. (e) Let the firm invest $6 millions in real assets; this leaves the shareholders with $4 millions today. Then borrow $2 millions at 10% from period 1 (next year) consumption using the capital markets; this provides shareholders with an additional $2 millions today, for a total of $6 millions. 8
9 (f) Next year, the firm s real investments will have generated $8.8 millions, but the shareholders owe 2(1.1) = $2.2 millions. Their consumption (spending) in period 1 will therefore be = $6.6 millions. 7. We can forecast the unlevered net income for this project as follows (all numbers in 000): End of year Sales 5,000 5,500 6,500 Cost of Goods Sold 2,5002,5002,500 Gross Profit 2,500 3,000 4,000 General & Administrative 1,3001,3001,300 Depreciation EBIT 600 1,100 2,100 Income Tax (35%) Unlevered Net Income ,365 To calculate the project s free cash flows, we need to add back depreciation, subtract capital expenditures, and subtract annual changes in net working capital. The initial capital expenditure is $2,400,000. In year 3, the equipment sale will generate a positive cash flow of $800,000. The excess over the book value of the machine (2.4M 0.6M 0.6M 0.6M = 600,000) is considered a taxable gain. The tax is 35% (800, ,000) = 70,000. Therefore, the net capital inflow from the sale of the machine in year 3 is 800,000 70,000 = 730,000. The following table shows how the annual changes in net working capital are calculated: End of year Cash Requirements Plus: Inventory Plus: Receivables Minus: Payables Net Working Capital Increase in NWC
10 The project s free cash flows are therefore as follows: End of year Unlevered Net Income ,365 Plus: Depreciation Minus: CapEx 2, Minus: Increase in NWC Free Cash Flow 2, ,265 2, The project s net present value is NPV = 2, ,265 (1.16) 2 + 2,595 (1.16) (1.16) 4 = 1, The solution spreadsheet is available on the Downloads section of the course s website. As shown in this spreadsheet, the project s free flows are as follows: End of year Revenues 40,000 40,000 40,000 Operating Costs 3,0003,0003,000 Depreciation 30,00048,00028,000 EBIT 7,00011,000 8,200 Income Tax (35%) 2,450 3,8502,870 Unlevered Net Income 4,5507,150 5,330 Depreciation 30,000 48,000 28,800 Capital Expenditures 150,000 54,120 Free Cash Flow 150,000 34,550 40,850 88,250 The project s net present value is NPV = 150, , ,850 (1.12) ,250 (1.12) 3 = 23,772. Alternatively, one could calculate the project s NPV as NPV = cost of equipment+pv(aftertax net operating profits) +PV(depreciation tax shield)+pv(equipment sale) PV(tax on equipment sale). 10
11 These PV s are calculated as follows: [ ( ) ] 40,000 3, PV(aftertax net operating profits) = (1 0.35) 1 = 57,764.04; [ 0.2 P V(depreciation tax shield) = 0.35(150,000) (1.12) ] (1.12) 3 = 29,942.60; PV(equipment sale) = 60,000 (1.12) 3 = 42,706.81; PV(tax on equipment sale) = 0.35[ 60,000 ( )150,000 ] (1.12) 3 = 4, Again, this gives us NPV = 23, < 0. So Nalyd should not purchase this equipment. 9. The solution spreadsheet is available on the Downloads section of the course s website. To find the breakeven price (of 60,019) using Excel, we make use of Goal Seek : Without Excel, the calculations are as follows. The current book value of the old harvester is ( ) 50,000 50,000 5 = 25, The incremental cash flow at t = 0 if the new harvester is purchased is therefore C 0 = 20, (25,000 20,000) P = 21,700 P where we have have taken into account the tax effect of the book loss on the sale of the old harvester. The incremental cash flow between years 1 and 5 equals the aftertax cost savings plus the tax effect of the incremental depreciation: ( ) P C t = (1 0.34)10, ,000 = 4, P (t = 1,...,5) After year 5, the old harvester would have been completely depreciated, so that the incremental cash flow between years 6 and 9 is: C t = (1 0.34)10, P 10 = 6, P (t = 6,...,9) Finally, the incremental cash flow in year 10 reflects the incremental salvage value of the new harvester and the consequent tax increase: C 10 = (1 0.34)10, P +(5,000 1,000) 0.34(5,000 1,000) 10 = 9, P 11
12 The NPV of the project is then: NPV = 10 t=0 C t 1.15 t = 21,700 P + 4, P 0.15 ( 1 + 6, P 0.15 (1.15) 5 = 49, P. ( 1 ) 1 (1.15) 5 ) 1 (1.15) 4 + 9, P (1.15) 10 Setting NP V = 0 and solving for P gives P = 60,019. This is the maximum price that Conocococonut would be willing to pay for the new harvester. 10. See solution spreadsheet posted on the Downloads section of the course s website. 12
Chapter 09  Using Discounted CashFlow Analysis to Make Investment Decisions
Solutions to Chapter 9 Using Discounted CashFlow Analysis to Make Investment Decisions 1. Net income = ($74 $42 $10) [0.35 ($74 $42 $10)] = $22 $7.7 = $14.3 million Revenues cash expenses taxes paid =
More informationChapter 7 Fundamentals of Capital Budgeting
Chapter 7 Fundamentals of Capital Budgeting Copyright 2011 Pearson Prentice Hall. All rights reserved. Chapter Outline 7.1 Forecasting Earnings 7.2 Determining Free Cash Flow and NPV 7.3 Choosing Among
More informationNet Present Value and Capital Budgeting. What to Discount
Net Present Value and Capital Budgeting (Text reference: Chapter 7) Topics what to discount the CCA system total project cash flow vs. tax shield approach detailed CCA calculations and examples project
More informationCHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS
CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS Answers to Concepts Review and Critical Thinking Questions 1. In this context, an opportunity cost refers to the value of an asset or other input that will
More informationChapter 7 Fundamentals of Capital Budgeting
Chapter 7 Fundamentals of Capital Budgeting 71. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats.
More informationChapter 9 Cash Flow and Capital Budgeting
Chapter 9 Cash Flow and Capital Budgeting MULTIPLE CHOICE 1. Gamma Electronics is considering the purchase of testing equipment that will cost $500,000. The equipment has a 5year lifetime with no salvage
More informationCHAPTER 7: NPV AND CAPITAL BUDGETING
CHAPTER 7: NPV AND CAPITAL BUDGETING I. Introduction Assigned problems are 3, 7, 34, 36, and 41. Read Appendix A. The key to analyzing a new project is to think incrementally. We calculate the incremental
More informationCHAPTER 7. Fundamentals of Capital Budgeting. Chapter Synopsis
CHAPTER 7 Fundamentals of Capital Budgeting Chapter Synopsis 7.1 Forecasting Earnings A firm s capital budget lists all of the projects that a firm plans to undertake during the next period. The selection
More informationCash Flow Estimation. Topics to be covered
Cash Flow Estimation Topics to be covered Discount Cash Flow, Not Profit Discount Incremental Cash Flow  Include all direct effects.  Forget Sunk Costs  Include Opportunity Costs  Recognize the Investment
More informationCHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA
CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Basic 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the
More informationChapter 7: Fundamentals of Capital Budgeting
Chapter 7: Fundamentals of Capital Budgeting1 Chapter 7: Fundamentals of Capital Budgeting Big Picture: To value a project, we must first estimate its cash flows. Note: most managers estimate a project
More informationChapter 8: Fundamentals of Capital Budgeting
Chapter 8: Fundamentals of Capital Budgeting1 Chapter 8: Fundamentals of Capital Budgeting Big Picture: To value a project, we must first estimate its cash flows. Note: most managers estimate a project
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax
More informationCash Flow, Taxes, and Project Evaluation. Remember Income versus Cashflow
Cash Flow, Taxes, and Project Evaluation Of the four steps in calculating NPV, the most difficult is the first: Forecasting cash flows. We now focus on this problem, with special attention to What is cash
More information(Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics)
Capital Budgeting: Net Present Value vs Internal Rate of Return (Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics) Y O Lam Capital budgeting assists decision makers in a
More informationMidterm exam financiering/finance. <Front page>
Midterm exam financiering/finance Question 1 An agency problem can be alleviated by: A) requiring all organizations to be sole proprietorships. B) compensating managers in such a way that
More informationCHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA
CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After three years, the project
More informationChapter 6. 1. Your firm is considering two investment projects with the following patterns of expected future net aftertax cash flows:
Chapter 6 1. Your firm is considering two investment projects with the following patterns of expected future net aftertax cash flows: Year Project A Project B 1 $1 million $5 million 2 2 million 4 million
More informationCapital Budgeting Further Considerations
Capital Budgeting Further Considerations For 9.220, Term 1, 2002/03 02_Lecture10.ppt Lecture Outline Introduction The input for evaluating projects relevant cash flows Inflation: real vs. nominal analysis
More informationChapter 9. Year Revenue COGS Depreciation S&A Taxable Income Aftertax Operating Income 1 $20.60 $12.36 $1.00 $2.06 $5.18 $3.11
Chapter 9 91 We assume that revenues and selling & administrative expenses will increase at the rate of inflation. Year Revenue COGS Depreciation S&A Taxable Income Aftertax Operating Income 1 $20.60
More informationChapter 6. Making Capital Investment Decisions 60. Copyright 2013 by The McGrawHill Companies, Inc. All rights reserved.
Chapter 6 Making Capital Investment Decisions McGrawHill/Irwin Copyright 2013 by The McGrawHill Companies, Inc. All rights reserved. 60 What is capital budgeting? Should we build this plant? Chapters
More informationValuation Free Cash Flows. Katharina Lewellen Finance Theory II April 2, 2003
Valuation Free Cash Flows Katharina Lewellen Finance Theory II April 2, 2003 Valuation Tools A key task of managers is to undertake valuation exercises in order to allocate capital between mutually exclusive
More informationCapital Budgeting. Financial Modeling Templates
Financial Modeling Templates http://spreadsheetml.com/finance/capitalbudgeting.shtml Copyright (c) 20092014, ConnectCode All Rights Reserved. ConnectCode accepts no responsibility for any adverse affect
More informationFinance for Cultural Organisations Lecture 8. Capital Budgeting: Making Capital Investment Decisions
Finance for Cultural Organisations Lecture 8. Capital Budgeting: Making Capital Investment Decisions Lecture 8. Capital Budgeting: Making Capital Investment Decisions Understand how to determine the relevant
More informationChapter 5 Capital Budgeting
Chapter 5 Capital Budgeting Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. FixedIncome securities. Common stocks. Real assets (capital budgeting). Part C Determination
More informationCapital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows
Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Chapter 7: 1,5,7,8,27,32 Chapter 8: 1,3,5,8,13 (clarification for problem 13b:
More informationHow will the firm's total aftertax cash flows change if the new project is accepted?
NPV and Capital Budgeting: A Short Note on Estimation of Project Cash Flows (Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics) KC Chow The most important valuedriving decisions
More information( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100
Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded
More informationCapital Budgeting continued: Overview: (1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows
Capital Budgeting continued: Overview: (1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Chapter 7: 1,4,6,7,20,25 Chapter 8: 1,3,5,8,13 (clarification for problem 13b:
More informationFundamentals of Capital Budgeting
8 Fundamentals of Capital Budgeting LEARNING OBJECTIVES Identify the types of cash flows needed in the capital budgeting process Forecast incremental earnings in a pro forma earnings statement for a project
More informationEXAM 1 REVIEW QUESTIONS
EXAM 1 REVIEW QUESTIONS 1) Free cash flow. Consider the following financial statements for United Technologies Corp. What is UT's free cash flow (total cash flow from assets) for 2001? UNITED TECHNOLOGIES:
More informationChapter Review and SelfTest Problems
340 PART FOUR Capital Budgeting costs and cash revenues and costs. We also went over the calculation of depreciation expense under current tax law. 4. Some special cases encountered in using discounted
More informationKey Concepts and Skills
Key Concepts and Skills Chapter 9 Making Capital Investment Decisions Understand how to determine the relevant cash flows for a proposed investment Understand how to analyze a project s projected cash
More informationWill the future benefits of this project be large enough to justify the investment given the risk involved?
Chapter 1 The Overall Process Capital Expenditures Whenever we make an expenditure that generates a cash flow benefit for more than one year, this is a capital expenditure. Examples include the purchase
More informationAGENDA LEARNING OBJECTIVES ANALYZING PROJECT CASH FLOWS. Chapter 12. Learning Objectives Principles Used in This Chapter
Chapter 12 ANALYZING PROJECT CASH FLOWS AGENDA Learning Objectives Principles Used in This Chapter 1. Identifying Incremental Cash Flows 2. Forecasting Project Cash Flows 3. Inflation and Capital Budgeting
More informationWhich projects should the corporation undertake
Which projects should the corporation undertake Investment criteria 1. Investment into a new project generates a flow of cash and, therefore, a standard DPV rule should be the first choice under consideration.
More information5. Capital budgeting (part 1)
1 5. Capital budgeting (part 1) In this chapter, we will apply the tools discussed in the previous chapter. The focus in this chapter is developing estimates of the cash flows that should be considered.
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Hors d Age Cheeseworks has been paying a regular cash dividend
More informationSAMPLE FACT EXAM (You must score 70% to successfully clear FACT)
SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per year? a. $600,000.00 b.
More informationFinance 445 Practice Exam Chapters 1, 2, 5, and part of Chapter 6. Part One. Multiple Choice Questions.
Finance 445 Practice Exam Chapters 1, 2, 5, and part of Chapter 6 Part One. Multiple Choice Questions. 1. Similar to the example given in class, assume that a corporation has $500 of cash revenue and $300
More informationWeek 1: Solutions to HW Problems
Week 1: Solutions to HW Problems 101 a. Payback A (cash flows in thousands): Annual Period Cash Flows Cumulative 0 ($5,000) ($5,000) 1 5,000 (0,000) 10,000 (10,000) 3 15,000 5,000 4 0,000 5,000 Payback
More informationCHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS
CHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS Answers to Concepts Review and Critical Thinking Questions 1. In this context, an opportunity cost refers to the value of an asset or other input that will
More informationOverview of Lecture 9
Overview of Lecture 9 Taxes The Tax Code Calculating aftertax cash flows What Discount Rate to Use? Materials covered: Reader, Lecture 7 BM Chapter 6, pp. 121134. M. Spiegel and R. Stanton, 2000 1 Review:
More informationModule 2: Preparing for Capital Venture Financing Financial Forecasting Methods TABLE OF CONTENTS
Module 2: Preparing for Capital Venture Financing Financial Forecasting Methods Module 2: Preparing for Capital Venture Financing Financial Forecasting Methods 1.0 FINANCIAL FORECASTING METHODS 1.01 Introduction
More informationENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company
More informationChapter 10: Making Capital Investment Decisions
Chapter 10: Making Capital Investment Decisions Faculty of Business Administration Lakehead University Spring 2003 May 21, 2003 Outline 10.1 Project Cash Flows: A First Look 10.2 Incremental Cash Flows
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares
More informationCHAPTER 5. Interest Rates. Chapter Synopsis
CHAPTER 5 Interest Rates Chapter Synopsis 5.1 Interest Rate Quotes and Adjustments Interest rates can compound more than once per year, such as monthly or semiannually. An annual percentage rate (APR)
More informationChapter 7. Net Present Value and Other Investment Criteria
Chapter 7 Net Present Value and Other Investment Criteria 72 Topics Covered Net Present Value Other Investment Criteria Mutually Exclusive Projects Capital Rationing 73 Net Present Value Net Present
More informationChapter 8: Using DCF Analysis to Make Investment Decisions
FIN 301 Class Notes Chapter 8: Using DCF Analysis to Make Investment Decisions Capital Budgeting: is the process of planning for capital expenditures (long term investment). Planning process involves 1
More informationChapter 9 Making Capital Investment Decisions Introduction
Chapter 9 Making Capital Investment Decisions Introduction The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted These cash flows
More informationChapter 8. Using Discounted Cash Flow Analysis to Make Investment Decisions
Chapter 8 Using Discounted Cash Flow Analysis to Make Investment Decisions 82 Topics Covered Discounted Cash Flows (not Accounting Profits) Incremental Cash Flows Treatment of Inflation Separate Investment
More informationCHAPTER 8: ESTIMATING CASH FLOWS
CHAPTER 8: ESTIMATING CASH FLOWS 81 a. Straight line depreciation = ($15  $3)/10 = $1.20 Annual Tax Savings from Depreciation = $ 1.2 (0.4) = $0.48 Present Value of Tax Savings from Depreciation = $
More informationCourse 3: Capital Budgeting Analysis
Excellence in Financial Management Course 3: Capital Budgeting Analysis Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a concise overview of capital budgeting analysis. This course is recommended
More informationCapital Investment Analysis and Project Assessment
PURDUE EXTENSION EC731 Capital Investment Analysis and Project Assessment Michael Boehlje and Cole Ehmke Department of Agricultural Economics Capital investment decisions that involve the purchase of
More informationChapter 13 Capital Budgeting: Estimating Cash Flow and Analyzing Risk ANSWERS TO ENDOFCHAPTER QUESTIONS
Chapter 13 Capital Budgeting: Estimating Cash Flow and Analyzing Risk ANSWERS TO ENDOFCHAPTER QUESTIONS 133 Since the cost of capital includes a premium for expected inflation, failure to adjust cash
More informationChapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS
Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS 111 a. Cash flow, which is the relevant financial variable, represents the actual flow of cash. Accounting
More informationReal Estate. Refinancing
Introduction This Solutions Handbook has been designed to supplement the HP2C Owner's Handbook by providing a variety of applications in the financial area. Programs and/or stepbystep keystroke procedures
More informationFundamentals Level Skills Module, Paper F9. Section A. Monetary value of return = $3 10 x 1 197 = $3 71 Current share price = $3 71 $0 21 = $3 50
Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2014 Answers Section A 1 A Monetary value of return = $3 10 x 1 197 = $3 71 Current share price = $3 71 $0 21 = $3 50 2
More informationUnderstanding Financial Statements. For Your Business
Understanding Financial Statements For Your Business Disclaimer The information provided is for informational purposes only, does not constitute legal advice or create an attorneyclient relationship,
More informationMBA Financial Management and Markets Exam 1 Spring 2009
MBA Financial Management and Markets Exam 1 Spring 2009 The following questions are designed to test your knowledge of the fundamental concepts of financial management structure [chapter 1], financial
More informationCapital Budgeting Cash Flows
Learning Objectives 11 Capital Budgeting Cash Flows 1 Corporate Financial Management 3e Emery Finnerty Stowe 12 Calculate incremental aftertax cash flows for a capital budgeting project. Explain the
More informationChapter 7: Net Present Value and Capital Budgeting
Chapter 7: Net Present Value and Capital Budgeting 7.1 a. Yes, the reduction in the sales of the company s other products, referred to as erosion, should be treated as an incremental cash flow. These lost
More informationIntroduction to Discounted Cash Flow and Project Appraisal. Charles Ward
Introduction to Discounted Cash Flow and Project Appraisal Charles Ward Company investment decisions How firms makes investment decisions about real projects (not necessarily property) How to decide which
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate
More information1.1 Introduction. Chapter 1: Feasibility Studies: An Overview
Chapter 1: Introduction 1.1 Introduction Every long term decision the firm makes is a capital budgeting decision whenever it changes the company s cash flows. Consider launching a new product. This involves
More informationMerchandise Accounts. Chapter 7  Unit 14
Merchandise Accounts Chapter 7  Unit 14 Merchandising... Merchandising... There are many types of companies out there Merchandising... There are many types of companies out there Service company  sells
More informationMBA 8130 FOUNDATIONS OF CORPORATION FINANCE FINAL EXAM VERSION A
MBA 8130 FOUNDATIONS OF CORPORATION FINANCE FINAL EXAM VERSION A Fall Semester 2004 Name: Class: Day/Time/Instructor:. Read the following directions very carefully. Failure to follow these directions will
More information1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 $000 $000 $000 $000 $000 Sales income 6,084 6,327 6,580 6,844
Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2013 Answers 1 (a) Net present value of investment in new machinery Year 1 2 3 4 5 $000 $000 $000 $000 $000 Sales income 6,084
More informationBA 351 CORPORATE FINANCE. John R. Graham Adapted from S. Viswanathan LECTURE 5 LEASING FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY
BA 351 CORPORATE FINANCE John R. Graham Adapted from S. Viswanathan LECTURE 5 LEASING FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY 1 Leasing has long been an important alternative to buying an asset. In this
More informationUniversity of Rio Grande Fall 2010
University of Rio Grande Fall 2010 Financial Management (Fin 20403) Practice Questions for Midterm 1 Answers the questions. (Or Identify the letter of the choice that best completes the statement if there
More informationCAPITAL BUDGETING. Definition. Time Value of Money [TVM] TVM is the reward for postponement of consumption of money.
11 CAPITAL BUDGETING 1LO 1: Time Value of Money Definition Time Value of Money [TVM] TVM is the reward for postponement of consumption of money. Principle Rs.100 received today is greater than Rs. 100
More informationPRODUCTIVITY & GROWTH
Productivity Financial Tools There are a number of financial tools that can be used to measure the financial performance and potential contribution of improvement projects to the productivity of a business.
More informationYour Guide to Profit Guard
Dear Profit Master, Congratulations for taking the next step in improving the profitability and efficiency of your company! Profit Guard will provide you with comparative statistical and graphical measurements
More informationChapter 11 Cash Flow Estimation and Risk Analysis
Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO ENDOFCHAPTER QUESTIONS 111 a. Cash flow, which is the relevant financial variable, represents the actual flow of cash. Accounting income,
More information1.040 Project Management
MIT OpenCourseWare http://ocw.mit.edu 1.040 Project Management Spring 2009 For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms. Project Financial Evaluation
More informationStrategy and Analysis in Using NPV. How Positive NPV Arises
Strategy and Analysis in Using NPV (Text reference: Chapter 8) Topics how positive NPV arises decision trees sensitivity analysis scenario analysis breakeven analysis investment options AFM 271  Strategy
More informationFINANCIAL INTRODUCTION
FINANCIAL INTRODUCTION In earlier sections you calculated your cost of goods sold, overhead expenses and capital cost in order to help you determine the sales price of your product. In your business plan,
More informationCHAPTER 14 COST OF CAPITAL
CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,
More informationValuation. The Big Picture: Part II  Valuation
Valuation The Big Picture: Part II  Valuation A. Valuation: Free Cash Flow and Risk Apr 1 Apr 3 Lecture: Valuation of Free Cash Flows Case: Ameritrade B. Valuation: WACC and APV Apr 8 Apr 10 Apr 15 Lecture:
More informationNet Present Value and Other Investment Criteria
Net Present Value and Other Investment Criteria Topics Covered Net Present Value Other Investment Criteria Mutually Exclusive Projects Capital Rationing Net Present Value Net Present Value  Present value
More informationPart 7. Capital Budgeting
Part 7. Capital Budgeting What is Capital Budgeting? Nancy Garcia and Digital Solutions Digital Solutions, a software development house, is considering a number of new projects, including a joint venture
More informationInvestment Decisions and Capital Budgeting
Investment Decisions and Capital Budgeting FINANCE 350 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University 1 Issues in Capital Budgeting: Investment How should capital
More informationSolutions to Chapter 4. Measuring Corporate Performance
Solutions to Chapter 4 Measuring Corporate Performance 1. a. 7,018 Longterm debt ratio 0. 42 7,018 9,724 b. 4,794 7,018 6,178 Total debt ratio 0. 65 27,714 c. 2,566 Times interest earned 3. 75 685 d.
More informationNWC = current assets  current liabilities = 2,100
Questions and Problems Chapters 2,3 pp4547 1. Building a balance sheet. Penguin Pucks, Inc., has current assets of $3,000, net fixed assets $6,000, current liabilities of $900, and longterm debt of $5,000.
More informationSolutions to Chapter 8. Net Present Value and Other Investment Criteria
Solutions to Chapter 8 Net Present Value and Other Investment Criteria. NPV A = $00 + [$80 annuity factor (%, periods)] = $00 $80 $8. 0 0. 0. (.) NPV B = $00 + [$00 annuity factor (%, periods)] = $00 $00
More informationThe Time Value of Money
The Time Value of Money Future Value  Amount to which an investment will grow after earning interest. Compound Interest  Interest earned on interest. Simple Interest  Interest earned only on the original
More informationChapter 010 Making Capital Investment Decisions
Multiple Choice Questions 1. The changes in a firm's future cash flows that are a direct consequence of accepting a project are called cash flows. A. incremental b. standalone c. aftertax d. net present
More informationCapital Budgeting II. Professor: Burcu Esmer
Capital Budgeting II Professor: Burcu Esmer 1 Cash Flows Last chapter introduced valuation techniques based on discounted cash flows. This chapter develops criteria for properly identifying and calculating
More informationCHAPTER 11. Proposed Project. Incremental Cash Flow for a Project. Treatment of Financing Costs. Estimating cash flows:
CHAPTER 11 Cash Flow Estimation and Risk Analysis Estimating cash flows: Relevant cash flows Working capital treatment Inflation Risk Analysis: Sensitivity Analysis, Scenario Analysis, and Simulation Analysis
More informationFinancial Markets and Valuation  Tutorial 2: SOLUTIONS. Bonds, Stock Valuation & Capital Budgeting
Financial Markets and Valuation  Tutorial : SOLUTIONS Bonds, Stock Valuation & Capital Budgeting (*) denotes those problems to be covered in detail during the tutorial session Bonds Problem. (Ross, Westerfield
More informationGESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE
GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 20102011 Chapter 18 Capital Budgeting and Valuation with Leverage
More informationCompany Financial Plan
Financial Modeling Templates http://spreadsheetml.com/finance/companyfinancialplan.shtml Copyright (c) 20092014, ConnectCode All Rights Reserved. ConnectCode accepts no responsibility for any adverse
More informationTOPIC 1 Cash Flow Estimation
COURSENOTES: TOPIC 1 Cash Flow Estimation COURSE TITLE: FINANCIAL MANAGEMENT COURSE CODE: BFB3013 PREPARED BY: ASSOC. PROF. MOHD KHIR ASHARI 1 1.0 Introduction: Topic 1 Cash Flows Estimation 1.1 Capital
More informationMBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the
MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the following 33 questions designed to test your knowledge of the
More informationChapter 13 Income Taxes
Chapter 13 Income Taxes 131 A tool costing $300 has no salvage value and will be depreciated over 3 years according to the sumoftheyearsdigits method. The cash flows before tax due to the tool are
More informationCHAPTER 10: UNCERTAINTY AND RISK IN CAPITAL BUDGETING: PART I
CHAPTER 10: UNCERTAINTY AND RISK IN CAPITAL BUDGETING: PART I 101 Year ATCF 02,500,000 Initial Investment = $2,500,000 1 $1,280,000 Annual Operating Cash Flows 2 $1,280,000 Revenues $5,000,000 3 $1,280,000
More information6. Financial Planning. Breakeven. Operating and Financial Leverage.
6. Financial Planning. Breakeven. Operating and Financial Leverage. Financial planning primarily involves anticipating the impact of operating, investment and financial decisions on the firm s future
More informationSOLUTIONS. Practice questions. Multiple Choice
Practice questions Multiple Choice 1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has 10,000 shares outstanding and a stock price of $10. If the unlevered beta
More information