1. During 1998, the Senbet Discount Tire Company had gross sales of $1 million. The firmâ??s cost of goods sold and selling expenses were $300,000 and $200,000, respectively. These figures do not include depreciation. Senbet also had notes payable of $1 million. These notes carried an interest rate of 10 percent. Depreciation was $100,000. Senbetâ??s tax rate in 1998 was 35 percent.
a. What was Senbetâ??s net operating income?
b. What were the firmâ??s earnings before taxes?
c. What was Senbetâ??s net income?
d. What was Senbetâ??s operating cash flow?
2. Consider the following cash flows on two mutually exclusive projects that require an annual return of 15 percent. Working in the financial planning department for the Bahamas Recreation Corp., you are trying to compare different investment criteria to arrive at a sensible choice of these two projects.
Year Fishing Ride Deepwater New Submarine
0 _$600,000 _$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
a. Based on the discounted payback period rule, which project should be chosen?
b. If your decision rule is to accept the project with a greater IRR, which project should you choose?
c. Since you are fully aware of the IRR ruleâ??s scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?
d. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
3. Calgary Industries, Inc., is considering a new project that costs $25 million. The project will generate after-tax (year-end) cash flows of $7 million for five years. The firm has a debt-to-equity ratio of 0.75. The cost of equity is 15 percent and the cost of debt is 9 percent. The corporate tax rate is 35 percent. It appears that the project has the same risk as that of the overall firm. Should Calgary take on the project?
4. Explain what are the corporationâ??s advantages and disadvantages of the corporation form?
The solution explains some questions relating to cash flows, payback, IRR and NPV