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Capital Budgeting

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1) Tangshan Mining Company is considering investing in a new mining project. The firm's cost of capital is 12 percent and the project is expected to have an initial after tax cost of $5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3 and ($1,300,000) in year 4? (5 points)
(a) Calculate the project's NPV. (b) Calculate the project's IRR.
(c) Should the firm make the investment?

2) Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after tax operating cash flows? Why or why not? (2 points)

3) Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost. (2 points)

Table 2

4) Given the information in Table 2 and 15 percent cost of capital. (3 points) (a) compute the net present value.
(b) should the project be accepted?

Table 3

Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.

The firm pays 40 percent taxes on ordinary income and capital gains.

6) Calculate the book value of the existing asset being replaced. (See Table 3) (2 points)

7) Calculate the tax effect from the sale of the existing asset. (See Table 3) (2 points)

8) Calculate the initial investment required for the new asset. (See Table 3) (2 points)

9) Calculate the earnings before depreciation and taxes. (See Table 3) (2 points)

10) Calculate the accumulated depreciation. (See Table 3) (2 points)

11) Summarize the incremental operating cash flow (relevant cash flows) for years t = 0 through t = 5. (See Table 3) (4 points)

12 ) Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of

$36 a share. Its beta is 0.5. Market expected return is 12% and risk-free rate is 5%. Jake's also has

6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon, pay interest annually, and mature in 5 years. The bonds are selling at $990. The company's tax rate is
34%. What is Jake's weighted average cost of capital? ( 3 points)

13) You are considering the following two mutually exclusive projects. (7 points)
Year Project A Project B
0 -$32,000 -$32,000
1 13,000 19,000
2 13,000 12,000
3 19,000 12,000

a) What are the NPVs for Project A and Project B given a discount rate of 14%.
A B A) 1500 2800
B) 3500 1300
C) 2231 2000
D) 2000 2231
b) What are the IRRs for Project A and Project B?
A B
A) 10.23% 12%
B) 35.40% 13%
C) 17.85% 18%
D) 25% 20%

c) What are the payback periods assuming all the cash flows come in evenly during the year
(in years)?
A B
A) 1.0 2.0
B) 3.2 1.34
C) Never payback 1.52
D) 2.3 2.08

d) Based on your analysis above, which project should be chosen and why?

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Solution Summary

Capital budgeting techniques and capital budgeting cash flows and risk refinements

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