Traditional Quiz 3

The _______ approach is used by corporations that attempt to consider differential project risk in their capital budgeting procedures.

risk adjusted discount rate

A new security system has a price-tag of $7,000, but should save your company $3,450 each year for the next 10 years in reduced thefts. What is the NPV of the security system? Use a discount rate of 10.8%.

1

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 5 years. At the end of the fifth year, the machine will be sold for $20,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%.What is the NPV of the project?

10

Hampton Corporation has a beta of 1.6 and a marginal tax rate of 34%. The expected return on the market is 11% and the risk-free interest rate is 6%. Estimate the firm's cost of internal equity.

11

Joliet Company is planning to issue $1,000 par value bonds that have a coupon rate of 9.6%. The bonds will be sold at a market price of $1,120. Flotation costs will amount to 4 percent of market value. The bonds would mature in 15 years and coupon payments would be semi-annual. Joliet's corporate tax rate is 35%. What is the firm's cost of debt financing?

12

SanData Inc. recently paid its annual dividend of $1.55. Dividends have consistently grown at a rate of 8%. You estimate that the stock has a required return of 19%. What is the intrinsic value of this stock?

13

The preferred stock of Dallas Platinum Exchange has a par value of $48 and pays a 7% dividend rate per year. You calculated a beta of 0.59 for the stock. The risk-free rate is 3.66% and the market return is 9.2%. Assuming that CAPM holds, what is the intrinsic value of this preferred stock?

14

Bay Beach Industries wants to maintain their capital structure of 40% debt and 60% equity. The firm's tax rate is 34%. The firm can issue the following securities to finance the investments: Bonds: Mortgage bonds can be issued at a pre-tax cost of 10.0 percent. Debentures can be issued at a pre-tax cost of 12.0 percent. Common Equity: Some retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $50. Flotation costs will be $2 per share. The recent common stock dividend was $7.08. Dividends are expected to grow at 6% in the future. What is the cost of capital using mortgage bonds and internal equity?

15

A $54,000 machine with a 5-year class life was purchased 2 years ago. The machine will now be sold for $50,000 and replaced with a new machine costing $97,000, with a 10-year class life. The new machine will not increase sales, but will decrease operating costs by $13,000 per year. Simplified straight line depreciation is employed for both machines, and the marginal corporate tax rate is 34 percent. What is the incremental annual cash flow associated with the project?

16

A $89,000 machine with a 7-year class life was purchased 5 years ago. The machine will now be sold for $20,000 and replaced with a new machine costing $63,000, with a 5-year class life. The new machine will not increase sales, but will decrease operating costs by $16,000 per year. Simplified straight line depreciation is employed for both machines, and the marginal corporate tax rate is 34 percent. What is the initial outlay for the project?

17

Riverview Company is evaluating the proposed acquisition of a new production machine. The machine's base price is $200,000, and installation costs would amount to $28,000. Also, $10,000 in net working capital would be required at installation. The machine will be depreciated for 3 years using simplified straight line depreciation. The machine would save the firm $110,000 per year in operating costs. The firm is planning to keep the machine in place for 5 years. At the end of the fifth year, the machine will be sold for $20,000. Riverview has a cost of capital of 12% and a marginal tax rate of 34%.What is the IRR of the project?

18

Southern Corporation has a capital structure of 40% debt and 60% common equity. This capital structure is expected not to change. The firm's tax rate is 34%. The firm can issue the following securities to finance capital investments: Debt: Capital can be raised through bank loans at a pretax cost of 8.2%. Also, bonds can be issued at a pretax cost of 7.3%. Common Stock: Retained earnings will be available for investment. In addition, new common stock can be issued at the market price of $90. Flotation costs will be $3 per share. The recent common stock dividend was $4.76. Dividends are expected to grow at 5% in the future. What is the cost of external equity?

19

A rider-mower costs $594 and generates an annual after-tax cash flow of $330 for your landscaping business. What is the payback period of the mower?

2

Hampton Corporation has a beta of 1.79 and a marginal tax rate of 34%. The expected return on the market is 14% and the risk-free interest rate is 2.46%. Estimate the firm's cost of internal equity.

20

By purchasing training software for $7,000, you can eliminate other training costs of $3,450 each year for the next 10 years. What is the profitability index of the software? Use a discount rate of 10.4%.

3

A new security system has a price-tag of $8,000, but should save your company $3,000 each year for the next 10 years in reduced thefts. What is the IRR of the security system?

4

Given the following cash flows for two mutually exclusive projects, and a required rate of return of 12%, which of the following statements is true? Year Project A Project B 0 -580,000 -580,000 1 290,000 130,000 2 290,000 130,000 3 150,000 230,000 4 150,000 230,000 5 230,000 6 115,000

5

Gizmo Industries is currently selling for $91. It just paid its annual dividend of $5, which have consistently grown at a rate of 6.6%. What is the expected return of this stock?

6

Broden, Inc. recently issued $63 par value preferred stock that pays an annual dividend of $17. If the stock is currently selling for $95, what is the expected return of this preferred stock?

7

Colonnade Corporation purchased a machine for use in the firm's manufacturing process. The original cost of the machine was $1,800,000. The machine has a class life of 15 years, but after 13 years, the firm has decided to sell the machine for $320,000. If Colonnade has a marginal tax rate of 34%, what is the tax effect associated with the decision? Assume the machine was depreciated straight-line over the 15-year life to zero salvage value.

8

Crossroad Corporation is trying to decide whether to invest to automate a production line. If the project is accepted, labor costs will decrease by $680,000 per year. However, other cash operating expenses will increase by $165,000 per year. The equipment will cost $173,000 and is depreciable over 12 years using simplified straight line to a zero salvage value. Crossroad will invest $47,000 in net working capital at installation. The firm has a marginal tax rate of 34%. Calculate the firm's annual cash flows associated with the new project.

9

Which of the following cash flows are not considered in the calculation of the initial outlay for a capital investment proposal?

cost of issuing new bonds to finance the new project.