Nguyen, INC. is considering the purchase of a new computer system (ICX) for $130,000. The system will require an additional $30,000 for installation. If the new computer is purchased, it will replace an old system that has been fully depreciated. The new system will be depreciated under the MACRS rules applicable to 7-year class assets. If the ICX is purchased, the old system will be sold for $20,000. The ICX system, which has a useful life of 10 years, is expected to increase revenues by $32,000 per year over its useful life. Operating costs are expected to decrease by $2,000 per year over the life of the system. The firm is taxed at a 40 percent marginal rate.
a. What net investment is required to acquire the ICX system and replace the old system?
b. Compute the annual net cash flows associated with the purchase of the ICX system.
2-Fred and Frieda have always wanted to enter the blueberry business. They locate a 50- acre piece of hillside in Maine that is covered with blueberry bushes. They figure that the annual yield from the bushes will be 200 crates. Each crate is estimated to sell for $400 for the next 10 years. This price is expected to rise to $500 per crate for all sales from years 11 through 20.
In order to get started, Fred and Frieda must pay $150,000 for the land plus $20,000 for packing equipment. The packing equipment will be depreciated on a straight-line basis to a zero estimated salvage value at the end of 20 years. Fred and Frieda believe that at the end of 20 years, they will want to retire to Florida and sell their property.
Annual operating expenses, including salaries to Fred and Frieda and exclusive of depreciation, are estimated to be $50,000 per year for the first 10 years and $60,000 thereafter. The land is expected to appreciate in value at a rate of 5 percent per year. The couple’s marginal tax rate is 30 percent for both ordinary income and capital gains and losses.
a. If the couple requires at least a 13 percent return on their investment, should they enter the blueberry business?
b. Assume that the land can be sold for only $50,000 at the end of 20 years (a capital loss of $100,000). Should the couple invest in the land and blueberry business? (Assume that the couple may claim the full amount of their capital loss in the year it occurs—year 20).
3-High Sky, Inc., a hot-air balloon manufacturing firm, currently has the following simplified balance sheet:
Assets Liabilities and Capital
Total Assets $ 1,100,000 Bonds (10% interest) $ 600,000
Common Stock at par ($3), 100,000
shares outstanding $ 300,000
Contributed capital in excess of par $ 100,000
Retained earnings $ 100,000
Total libalities and capital $ 1,100,000
The company is planning an expansion that is expected to cost $600,000. The expansion can be financed with new equity (sold to net the company $4 per share) or with the sale of new bonds at an interest rate of 11 percent. (The firm’s marginal tax rate is 40 percent.)
1. Compute the indifference point between the two financing alternatives.
2. If the expected level of EBIT for the firm is $240,000 with a standard deviation of $50,000, what is the probability that the debt financing alternatives will produce higher earnings than the equity alternative? (EBIT is normally distributed.)
3. If the debt alternative is chosen, what is the probability that the company will have negative earnings per share in any period?
In an effort to speed up the collection of receivables, Hill Publishing Company is considering increasing the size of its cash discount by changing its credit terms from “1/10, net 30” to “2/10, net 30”. Currently, the company’s collection period averages 43 days. Under the new credit terms, it is expected to decline to 28 days. Also, the percentage of customers who will take advantage of the cash discount is expected to increase from the current 50 percent to 70 with the new credit terms. Bad-debt losses currently average 4 percent of sales and are not expected to change significantly if Hill changes its credit policy. Annual credit sales are $3.5 million, the variable cost ratio is 60 percent, and the required pretax rate of return (i.e., the opportunity cost) on receivable investment is 14 percent. The company does not expect its inventory level to change as a result of its proposed change in credit terms. Assuming that Hill does decide to increase the size of its cash discounts, determine the following:
1. The earning on the funds released by the change in credit terms
2. The cost of the additional cash discounts taken
3. The net effect on Hill’s pretax profits
5-Apex Corporation is considering the purchase of Pinnacle Company in a stock-for-stock exchange. Selected data on the two companies are shown in the following table:
Assume that there are no synergistic benefits as the result of the merger. Determine EPS for the combined company if Apex offers a
a. 20 percent premium for Pinnacle
b. 40 percent premium for Pinnacle
c. 50 percent premium forPinnacle