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# Finance questions

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Problems:

1. A company is analyzing two mutually exclusive projects, A and B, whose cash
flows are shown below:
Years o r= 10% 1
I
A -3,200 1,500
B -3,200 700
2 3
1700 1,500
o 4,700
The company's cost of capital is 10 percent, and it can get an unlimited amount of
capital at that cost. What is the IRR of the better project, i.e., the project which
the company should choose if it wants to maximize its stock price?
Project _ ~-----------------

2. You have been asked by the president of your company to evaluate the proposed
acquisition of a new special-purpose truck. The truck's basic price is \$320,000,
and it will cost another \$30,000 to modify it for special use by your firm. The
truck falls into the MACRS. three-year class, and it will be sold after three years
for \$40,000. Use of the truck will require an increase in net operating working
capital (spare parts inventory) of \$25,000. The truck will have no effect on
revenues, but it is expected to save the firm \$130,000 per year in before-tax
operating costs, mainly labor. The firm's cost of capital is 9% and the marginal
tax rate is 40 percent. Should the company accept/reject the project?
NPV IRR MIRR Decision _

3. ABC Bottling's December 31st balance sheet is given below:
Cash
Accounts receivable
Inventory
Net fixed assets
\$20
25
60
75
Accounts payable
Notes payable
Accrued wages and taxes
Long-term debt
Common equity
Total liabilities
and equity
\$40
20
15
35
70
Total assets

Sales during the past year were \$360, and they are expected to rise by 50 percent
to \$540 during next year. Also, during last year fixed assets were being utilized
to only 65 percent of capacity, so ABC could have supported \$360 of sales with
fixed assets that were only 65 percent of last year's actual fixed assets. Assume
that ABC's profit margin will remain constant at 6 percent and that the company
will continue to payout 40 percent of its earnings as dividends. To the nearest
whole dollar, what amount of non-spontaneous, additional funds (AFN) will be
needed during the next year (use pro-forma method)?
..----~---------------------------------------

4. A group of graduate students has decided to form a small Internet Service
Company in Brevard County. The company will service Brevard County home
users and need \$200 million to start the company. Two financing plans have
been proposed by the investment banking firms. Plan A is an all commonequity
alternative. Under this agreement, 2 million common shares will be
sold to net the firm \$100 per share. Plan B involves the use of financial
leverage (debt and equity). A debt issue with a 20-year maturity period will
be privately placed. The debt issue will carry an interest rate of 10 percent,
and the principal borrowed will amount to \$80 million. The corporate tax
rate is 40 percent. If the detailed financial analysis projects that there is a
30% chance that EBITwill be \$6.0 million, 40% chance that it will be \$8.0
million, and 30% chance that it will be \$10 million annually, which plan will
maximize the wealth ofthe stockholders? (note: the problem is based on the
understanding of financial statement and financial leverage)

Plan _

5. ABC is considering a leasing arrangement to finance some special
manufacturing tools that is needed for production during the next four years.
A planned change in the firm's production technology will make the tool
obsolete after 4 years. The firm will depreciate the cost of the tools on a
straight-line basis. The firm can borrow \$4,000,000, the purchase price, at
10% to buy the tools or make four equal end of the year lease payments of
\$1,200,000. The firm's tax rate is 34% and the firm's before-tax cost of debt
is 10%. Annual maintenance costs associated with ownership are estimated
at \$200,000. Should the firm lease or buy?

Decision: _

#### Solution Summary

The solution explains various finance questions relating to mutually exclusive projects, IRR, NPV, MIRR, AFN, leverage and lease

\$2.19

## Answers to Various Financial Questions

Jenny just married Tim. Jenny remains to work as a cashier for a restaurant, and her monthly income has averaged \$2,840 a month over the past year. Tim is working as a computer programmer and earns \$3,000 a month. Their shared monthly income let them to live comfortably. Yet they have been unable to save any money for urgent situation.
According to Tim, "It's hard to believe, but we don't even have a savings account because we spend almost everything we make." Every month, they deposit each of their paychecks in separate checking accounts. Tim pays the rent and makes the car payment. Pam buys the groceries and pays the utilities. They use the money left over to purchase new clothes and the other "necessities" for enjoying life.
In an effort to make wise use of credit, the Turner have examined various sources that could serve their current and future financial needs. In the assessment process, they compared the APR along with various fees and potential charges.
Tim and Jenny are also learning about various actions that might be useful if they encounter credit troubles. Their discussions with friends and money management advisers provided expanded knowledge of credit counseling and bankruptcy alternatives.
Life Situation Financial Data
Recently Married
Pam, 26
Josh, 28
Renting an Apartment Monthly income \$5,840
Living expenses \$3,900
Assets \$13,500
Liabilities \$4,800
Emergency fund \$1,000

Q1. What is the minimum amount that the Turner should have in an emergency fund? What actions might be taken to increase the amount in this fund?

1. Lucy lacks cash to pay for a \$720 dishwasher. She could buy it from the store on credit by making 12 monthly payments of \$65. The total cost would then be \$780. Instead, Lucy decides to deposit \$60 a month in the bank until she has saved enough money to pay cash for the dishwasher. One year later, she has saved \$770.40—\$720 in deposits plus interest. When she goes back to the store, she finds the dishwasher now costs \$849.60. Its price has gone up 18 percent, the current rate of inflation.
From the financial standpoint, was postponing her purchase a good trade-off for Lucy?

Yes ___
No ___

2. Malou is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Malou is living at home and works in a shoe store, earning a gross income of \$3250 per month. Her employer deducts a total of \$150 for taxes from her monthly pay. Malou also pays \$100 on credit card debt each month. The loan she needs for chiropractic school will cost an additional \$140 per month.
Calculate her debt payments-to-income ratio without college loan. Remember to convert your answer to a percentage!

3. Sally is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Sally is living at home and works in a shoe store, earning a gross income of \$2990 per month. Her employer deducts a total of \$200 for taxes from her monthly pay. Sally also pays \$100 on credit card debt each month. The loan she needs for chiropractic school will cost an additional \$100 per month.
Calculate her debt payments-to-income ratio with college loan. Don't forget to convert your answer to a percentage.