1) A project costs $100,000 and yields annual cash flows of $40,000 for 5 years. The required rate of return is 6%. Compute the following:
2) What two problems are involved with the payback period?
3) In capital budgeting, explain two reasons why a firm would impose capital rationing upon itself.
4) What is a disadvantage of scenario analysis? What is a disadvantage of sensitivity analysis?
5) What are two common characteristics of firms that have high levels of debt?
6) Why is newly issued common stock the most expensive form of capital?
7) The Heins Company is evaluating the proposed acquisition of a new piece of equipment. The equipment's base price is $50,000, and it would cost another $10,000 to modify it as needed by the company. Depreciation is: year 1 $27,000; year 2 $19,800; year 3 $9,000. The equipment would be sold at the end of year 3 for $20,000. The equipment would have no effect on revenues but would save the company $25,000 per year in before-tax operating expenses, mainly labor. The company's marginal tax rate is 30%.
a. What is the net cost of the equipment for capital budgeting purposes?
b. What are the net operating cash flows for years 1, 2, and 3?
c. What is the additional year 3 cash flow?
d. If the cost of capital is 10%, should be project be undertaken? Why or why not?
This solution provides assistance with the finance computations required.