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# Capital Budget

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I have read my assigned chapter thoroughly however; I am lost on the attached problems.

1.

Calculate in the net present value and profitability index of a project with a net investment of \$20,000 and expected net cash flows of \$3,000 a year for 10 years if the project's required return is 12 percent. Is the project acceptable?

2.

A firm wishes to bid on a contract that is expected to yield the following after-tax net cash flows at the end of each year:

Year Net Cash Flow
1 \$5,000
2 8,000
3 9,000
4 8,000
5 8,000
6 5,000
7 3,000
8 \$-1,500

To secure the contract, the firm must spend \$30,000 to retool its plant. This retooling will have no salvage value at the end of the 8 years. Comparable investment alternatives are available to the firm that earns 12 percent compounded annually. The depreciation tax benefit from the retooling is reflected in the net cash flows in the table.

a. Compute the project's net present value.
b. Should the project be adopted?
c. What is the meaning of the computed net present value figure?

6.

Two mutually exclusive investment projects have the following forecasted cash flow:

Year A B
0 \$-20,000 \$-20,000
1 10,000 0
2 10,000 0
3 10,000 0
4 10,000 0

a. Compute the internal rate of return for each project.
b. Compute the net present value for each project if the firm has 10 percent cost of capitol
c. Which projects should be adopted? Why?

13.

Note the following information on the annual cash flows of two mutually exclusive projects under consideration by Wan Food Markets, Inc.

Year A B
0 \$-30,000 \$-60,000
1 10,000 10,000
2 10,000 10,000
3 10,000 10,000
4 10,000 10,000
5 10,000 10,000

Wang requires a 14 percent rate of return on projects of this nature.

a. Compute the NPV of both projects
b. Compute the internal rate of return on both projects
c. Compute the profitability index of both projects
d. Compute the payback period on both projects
e. Which of the two projects, if either, should Wang accept? Why?

9.
A junior executive is fed up with his boss's operating policies. Before leaving the office of his angered superior, the young man suggests that a well-trained monkey could handle the trivia assigned to him. Pausing a moment to consider the import of this closing statement, the boss is seized by the thought that this must have been in the back of her own mind ever since she hired the junior executive. She decides to consider replacing the executive with a bright young baboon. She figures that she could argue strongly to the board that such "capitol deepening" is necessary for the cost-conscious firm. Tow days later, a feasibility study is completed, and the following data are presented to the president:

? It would cost \$12,000 to purchase and train a reasonably alert baboon with a life expectancy of 20 years.
? Annual expenses of feeding and housing the baboon would be \$4,000
? The junior executive's annual salary is \$7,000 (a potential saving if the baboon is hired).
? The baboon will be depreciated on a straight-line basis over 20 years to a zero balance.
? The firm's marginal tax rate is 40 percent
? The firm's current cost of capital is estimated to be 11 percent

10.

Consider a 2-year project with the following information: initial fixed asset investment= \$495,000; straight-line depreciation to zero over the 2-year life; zero salvage value; selling price =\$39; variable costs = 20; fixed cost = \$210,000; quantity sold = 150,000 units; tax rate = 31 percent. How sensitive is Operating Cash Flow to changes in quantity sold? State your answer in terms of a dollar amount change (increase or decrease) in Operating Cash Flow for every additional unit sold

\$2.19

## Cost of Capital, Capital Budgeting, Capital Structure, Forecasting, and Working Capital Management

Question 1: (Cost of Capital)

You are provided the following information on a company. The total market value is \$38 million. The company's capital structure, shown here, is considered to be optimal.
(see attached file for data)

a. What is the after-tax cost of debt? (assume the company's effective tax rate = 40%)
b. Assuming a \$4 dividend paid annually, what is the required return for preferred shareholders (i.e. component cost of preferred stock)? (assume floatation costs = \$0.00)
c. Assuming the risk-free rate is 1%, the expected return on the stock market is 7%, and the company's beta is 1.0, what is the required return for common stockholders (i.e., component cost of common stock)?
d. What is the company's weighted average cost of capital (WACC)?

Question 2: (Capital Budgeting)

It's time to decide how to use the money your firm is expected to make this year. Two investment opportunities are available, with net cash flows as follows:
(See attached file for data)

a. Calculate each project's Net Present Value (NPV), assuming your firm's weighted average cost of capital (WACC) is 7%
b. Calculate each project's Internal rate of Return (IRR).
c. Plot NPV profiles for both projects on a graph).
d. Assuming that your firm's WACC is 7%:
(1) If the projects are independent which one(s) should be accepted?
(2) If the projects are mutually exclusive which one(s) should be accepted?

Question 3: (Capital Structure)

Aaron Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
(See attached file for data)

The company's tax rate, T, is 40 percent. The company uses the CAPM to estimate its cost of common equity, Rs. The risk-free rate is 1 percent and the market risk premium is 6 percent. Aaron estimates that if it had no debt its beta would be 1.0. (i.e., its "unlevered beta," bU, equals 1.0.)

On the basis of this information, what is the company's optimal capital structure, and what is the firm's cost of capital at this optimal capital structure?

Question 4: (Forecasting)

A firm has the following balance sheet:
(See attached file for data)

Sales for the year just ended were \$6,000, and fixed assets were used at 80 percent of capacity. Current assets and accounts payable vary directly with sales. Sales are expected to grow by 20 percent next year, the expected net profit margin is 5 percent, and the dividend payout ratio is 80 percent.

How much additional funds (AFN) will be needed next year, if any?

Question 5: Working Capital Management

The Chickman Corporation has an inventory conversion period of 60 days, a receivables collection period of 30 days, and a payables deferral period of 30 days. Its annual credit sales are \$6,000,000, and its annual cost of goods sold (COGS) is 60% of sales.

a. What is the length of the firm's cash conversion cycle?
b. What is the firm's investment in accounts receivable?
c. What is the company's inventory turnover ratio?
d. Identify three ways in which the company could reduce its cash conversion cycle?
e. What are the possible risks of reducing the cash conversion cycle per your recommendations in part d?

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