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Capital Budgeting

Need to discuss these questions in class.

Waste Industries is evaluating a $70,000 project with the following cash flows.

Year Cash Flows
1 $11,000
2 16,000
3 21,000
4 24,000
5 30,000

The coefficient of variation for the project is .847.

Based on the following table of risk-adjusted discount rates, should the project be undertaken? Select the appropriate discount rate and then compute the net present value.

Coefficient of Variation Discount Rate
0 - .25 6%
26 - .50 8
. 51 - .75 10
76 - 1.00 14
1.01 - 1.25 20

The warrants of Integra Life Sciences allow the holder to buy a share of stock at $11.75 and are selling for $2.85. The stock price is currently $8.50. What price must the stock go to for the warrant purchaser to at least be assured of breaking even?

The Redford Investment Company bought 100 Cinema Corp. warrants one year ago and would like to exercise them today. The warrants were purchased at $24 each, and they expire when trading ends today (assume there is no speculative premium left.) Cinema Corp. common stock is selling today for $50 per share. The exercise price is $30 and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.

a. If the warrants are exercised today, what would the Redford Investment Company's dollar profit or loss be?
b. What is the Redford Investment Company's percentage rate of return?

The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for $3 million. Kent has a $700,000 tax loss carry-forward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 30 percent. Kent will provide $420,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If the Clark Corporation has a cost of capital of 13 percent, should the merger be undertaken?

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Waste Industries is evaluating a $70,000 project with the following cash flows.

Year Cash Flows
1 $11,000
2 16,000
3 21,000
4 24,000
5 30,000

The coefficient of variation for the project is .847.

Based on the following table of risk-adjusted discount rates, should the project be undertaken? Select the appropriate discount rate and then compute the net present value.

Coefficient of Variation Discount Rate
0 - .25 6%
26 - .50 8
. 51 - .75 10
76 - 1.00 14
1.01 - 1.25 20

Answer
Based on the coefficient of variation, the discount rate would be 14%
We calculate the NPV
NPV is -70,000 + 11,000/1.14 + 16,000/1.14^2 + 21,000/1.14^3 + 24,000/1.14^4 + 30,000/1.14^5
NPV = -$4,074
Since the NPV is negative the project should not be undertaken

The warrants of ...

Solution Summary

The solution explains various problems relating to capital budgeting

$2.19