Part -1:
1. Which of the following cash flows Should be treated as incremental cash flow when computing the NPV of an investment? Explain
a. the annual depreciation expense
b. Dividend payments
c. The resale value of plant and equipment at the end of the project's life.
d. Salary and medical costs for production employees on leave.
e. The reduction in the stiles of the company's other products.
f The expenditure on plant and equipment.
h. The cost of research and development undertaken In connection with the product the past three years.
2. A Dutch Petroleum Company is considering going into a new project, which is typical for the firm. A capital tool required for the project costs $900,000. The marketing department predicts that sales will be $100,000 per year for the next two years, after which the market will exist. The tool, a three-year class capital too), will be depreciated down to zero using the straight-line method. Cost of goods sold and operating expenses are predicted to be 25 percent of stiles. In two years the tool can be Sold for $200.000. The company also needs add net working capital of $100,000 immediately. Additional capital will he received in full at the end of the project life. The tax rate is 25 percent. The required rate of return on is percent. Should the company accept the project?
3. a) Securities A,B,C and D have the following characteristics:
|
Security
|
E(R)%
|
Beta
|
|
A
|
9%
|
0.5
|
|
B
|
11%
|
0.7
|
|
C
|
15%
|
1.2
|
|
D
|
21%
|
1.7
|
Are these securities priced in equilibrium? Show calculation.
b) The managers of P and G Company:, believe that by restructuring they can increase the value of the company. In order to increase the value of the company the managers is about to apply 60% debt and 40% equity Strategy in it's capital structure. Modigliani Miller Proposition I and Modigliani Miller Proposition 2 what would you suggest that managers should do?
4. Olbet Inc., it a non-growth company in the 35-percent tax bracket olbet's perpetual EBIT is $1.2 million per annum. The firm's pretax cost of debit is 8 percent and its interest expense per year is $200,000. Company analysts- estimates that the unlevered cost of the olbet's equity is 12 percent. The after tax, all, equity discount rate (r0) is 15 percent
a. What is the value of this firm?
b. According with Modigliani Miller preposition 2 about what is the above calculation imply about the level of debt?
Part -2:
1. Fiber glass must choose between two kind of facility 1 costs $2. 1 million and it's economic life in seven years. The maintenance cost of facility I are $60,000 per year. Facilities II costs $2.8 million and it lasts 10 years. The annual maintenance cost for facility II are $100,000 per year. Both facilities are fully depreciated by the straight line method. The facilities will have no values after their economic lives. The corporate tax rate is 34 percent. Revenues from the facilities are the same. The company is assumed to earn a sufficient amount of revenues to generate tax shields from depreciation. If the appropriate discount rate is 10 percent, which facility should fiber glasses choose?
2. a) Johnson Point stock has an expected return of 20 percent with a beta of 1.7, while William Tire stock has an expected return of 15percent with a beta of 0.5. Assume the CAPM is true. What is the expected return on the market? What is the risk free rate?
b) What is the risk of a security? Which components does the risk consist of? Why doesn't diversification eliminate all risk?
3. The Holland Company has perpetual EBIT of $4 million per year. The after tax all equity discount rate (r0) is 15 percent. The company's tax rate is 35 percent. The cost debt capital is 10 percent and Holland has $10 million of debt in its capital structure.
What is Holland's value?
What is Holland. cost of equity?
4. Your company currently produces and sells steel-shaft golf clubs. The board of directors wants you to look at introducing a new line of titanium bubble woods with graphite shaft. Which of the following costs are not relevant?
I . Land you already own that will be used for the project and has a market value of $70,000.
II. $300,000 drop in sales of steel-s-shaft clubs if titanium woods with graphite shaft are introduced.
III. $200,000 spirit on Research and development last year on graphite shafts
IV. The annual depreciation expense.
V. Dividend payments,
VI. $1 million salary and medical costs Par production employees on leave