Corporate Finance Final

Suppose you sell a fixed asset for $99,000 when its book value is $129,000. If your company's marginal tax rate is 39%, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

$110,700 129000 + (99000 - 129000)(1 - .39) = $110700

Your company is considering a new project that will require $2,000,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $250,000 using straight-line depreciation. The cost of capital is 12%, and the firm's tax rate is 39%. Estimate the present value of the tax benefits from depreciation.

$385,628 Depreciation = ($2,000,000 - $250,000)/10 = $175,000 $175,000 x .39 = $68250 tax savings each period. Across the entire project, these savings will constitute a 10 period annuity. Pmt = 68,250, FV = 0, I = 12, N = 10, PV = 385,627.72

Equipment was purchased for $45,000 plus $2,000 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis?

$49,500

Your company is considering a new project that will require $250,000 of new equipment at the start of the project. The equipment will have a depreciable life of 8 years and will be depreciated to a book value of $10,000 using straight-line depreciation. The cost of capital is 12%, and the firm's tax rate is 34%. Estimate the present value of the tax benefits from depreciation.

$50,669.93 Step 1: Annual depreciation expense = [250000 - 10000]/8 = 30000; Step 2: Tax benefit = 30000(.34) = 10200; Step 3: PV of tax benefits: PMT = 10200; FV = 0; N = 8; i = 12; = >PV = 50669.93

Suppose you sell a fixed asset for $75,000 when its book value is $80,000. If your company's marginal tax rate is 35%, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

$76,750 AT CF = $80,000 + ($75,000 - $80,000) x (1 - .35) = $76,750

A new project would require an immediate increase in raw materials in the amount of $12,000. The firm expects that accounts payable will automatically increase $8,500. How much must the firm expect its investment in net working capital to change if they accept this project?

+$3,500

We accept projects with a positive NPV because it means that ____________.

-We have recovered all our costs -We are creating wealth for shareholders -The project's expected return exceeds the cost of capital

A company is considering two mutually exclusive projects, A and B. Project A requires an initial investment of $100, followed by cash flows of $95, $20 and $5. Project B requires an initial investment of $100, followed by cash flows of $0, $20 and $130. What is the IRR of the project that is best for the company's shareholders? The firm's cost of capital is 10%.

15.24% Using a financial calculator: Project A: NPV = 6.65; IRR = 15.96%; Project B: NPV = 14.20; IRR = 15.24%; NPV is best statistic, therefore the IRR of the best project is 15.24%

Stock Companies

3M, Alcoa, American Express, AT&T, Bank of America, Boeing, Walt Disney, General Electric, IBM, Wal-Mart

A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7. The initial investment is $750. What is the payback for this investment?

4.88 years Accumulate the cash flows; 4 + (350/400) = 4.88 years

Yield to Maturity (YTM)

Discount rate that equates the present value of future cash flows with current bond price

The best approach to convert an infinite series of asset purchases into a perpetuity is known as the

Equivalent annual cost approach

Indenture agreement contains bond terms

Maturity date Par value Time to maturity Call feature Coupon Rate

Beta

Measures the sensitivity of a stock or portfolio to market risk

Zero-coupon bond

No interest payments Pays par value at maturity

Which of the following will decrease the additional funds needed from external sources?

The firm's retention ratio is increased.

Component Cost of Debt

Two-part calculation 1) Estimate before-tax cost of debt by using Yield to Maturity 2) Solve for interest rate that makes price equal to sum of present values for coupons and face value of bond

Bond Issuers

US Treasury $1,000 Corporations $1,000 Municipalities $5,000

WACC

Weighted Average Cost of Capital (WACC) is the average cost per dollar of capital raised. Weights are based on market values, not book values

Which of the following can be computed as: Necessary increase in assets minus spontaneous increase in liabilities minus projected increase in retained earnings?

additional funds needed

The set of assumptions underlying the firm's financial plan and the resulting projected financial statements are accordingly often referred to as which of the following?

base case projections

Neither payback period nor discounted payback period techniques for evaluating capital projects account for

cash flows that occur after payback.

A decrease in net working capital (NWC) is treated as a

cash inflow