PROBLEM 1: REPLACEMENT DECISION
ABC Inc. is debating the purchase of a new digital printer. The printer they acquired 3 years ago for $55,000 is worth $23,000 today, and will have a salvage value of $7,500 after 5 more years. It requires $5,500 per year in maintenance. Maintenance costs are incurred at the end of each year. The new printer will cost $70,000. It will cost $3,500 per year to maintain the new machine, maintenance costs will be incurred at the end of each year. The new machine will increase the company's annual revenue by $22,000 during its 5-year life. At the end of 5 years, it will have a salvage value of $18,000. Currently the company has $15,000 invested in operating net working capital. If the company purchases the new machine the investment in operating net working capital will decrease to $8,000. The company's corporate tax rate is 25%, the CCA rate is 30% and the required rate of return is 12%.
a) Using net present value (NPV) calculation, determine if the company should purchase the new digital printer. Show all work. (You will need to calculate the incremental cash flows.)
PROBLEM 2: PURCHASE DECISION
DEF Inc. is considering buying a bottling machine for $650,000. It will have a useful life of 3 years and a salvage value of $195,000. The machine has a rate of return is 8% and they have a corporate tax rate of 30%. The CCA rate is 25%. DEF would need to invest $15,000 in initial net working capital. DEF assumes that this project will generate the following pre-tax savings in operating costs (NOTE pre-tax savings are not the same as cash flow from the assets).
Year 1 $270,000
Year 2 $240,000
Year 3 $225,000
a) Calculate the exact Payback Period and the discounted Payback Period.
b) Calculate the IRR.
c) Calculate the NPV.
d) Should DEF Inc. purchase the machine based on the results from a), b) and c)?
Hint: A reduction in operating costs is the same as an increase in revenues.
PROBLEM 3: BID PRICE
Sarah works in the marketing department of a large firm. The firm has been approached by a client that wishes to order some silicone wristbands. The client will purchase 500,000 wrist bands each year for the next 5 years. In order to fulfill the order Sarah's firm would need to purchase a silicone wristband-maker, at a cost of $385,000. The machine can produce a maximum of 500,000 units each year. Sarah expects to use the machine for the next 5 years and then sell it for its salvage value of $120,000. The wrist bands have a variable cost of $0.80 per unit and there will be a fixed cost of $60,000 per year to operate the new machine. The CCA rate is 30%, corporate tax rate is 40.0% and appropriate discount rate is 11.0%. In order to successfully promote her event, at what price should Sarah set the minimum selling (bid) price per wristband? Show all work for full/part marks.
PROBLEM 4: RETURNS AND RISK ON STOCKS
You work for a small investment management firm. You have been provided with the following historical information for three stocks and the market index. The information is shown in the table below.
|
New Inc.
|
Old Inc.
|
Newer Inc.
|
|
|
Stock Price
|
Dividend
|
Stock Price
|
Dividend
|
Stock Price
|
Dividend
|
Market Index
|
|
2016
|
$160
|
$2.10
|
$80
|
$2.00
|
$50
|
$1.50
|
19,740
|
|
2015
|
$155
|
$1.90
|
$60
|
$1.50
|
$45
|
$1.40
|
18,320
|
|
2014
|
$162
|
$1.90
|
$76
|
$1.00
|
$55
|
$1.30
|
19,520
|
|
2013
|
$150
|
$1.90
|
$70
|
$1.00
|
$40
|
$1.20
|
21,325
|
|
2012
|
$155
|
$1.75
|
$60
|
$0.06
|
$35
|
$1.10
|
19,800
|
|
2011
|
$140
|
$1.60
|
$40
|
$0.40
|
$25
|
$1.00
|
19,020
|
|
2010
|
$135
|
$1.50
|
$30
|
$0.00
|
$20
|
$0.90
|
18,500
|
Using the data provided you are to calculate the following for each of the stocks and the market index.
a) What is the average annual return for the past six years?
b) What is the population standard deviation and the sample standard deviation?
c) What is the coefficient of variation for each of the stocks and the market index?
d) What is the beta of each of the stocks? You can use excel's slope function to estimate this.
PROBLEM 5: USING DIVIDENDS TO VALUE A STOCK
You are an analyst in charge of valuing common stocks. You are expected to give a buy-hold-sell recommendation for DEF, a pharmaceutical company specializing in anti-inflammatory drugs. Observing the current market trends, you expect future growth in this company. You expect the firm to pay its first dividend of $6.00 per share 2 years from today. You expect the dividends to increase by 50% the following year. The year after that dividends will increase by 40%, and then for the following 2 years dividends will increase by 20.0% and thereafter dividends will increase by 4% each year in perpetuity.
DEF's required rate of return is 20.0% for the next 2 years, 15% for the following 3 years and thereafter the required rate of return will be 12%.
a) From your analysis what is the value of DEF today?
b) If the company's stock was $50.00 in the market is the stock overvalued or undervalued?