1. Assume a corporation has earnings before depreciation and taxes of $118,000, depreciation of $46,000 and that it has a 40% tax bracket.
Compute its cash flow using the following format
Earnings before depreciation _______________
Depreciation ____________________________
Earnings before taxes _____________________
Taxes __________________________________
Earnings after taxes ______________________
Depreciation ____________________________
Cash flow _______________________________
How much would cash flow be if there were only $12,000 in depreciation? All other factors are the same.
Cash flow ________________________
How much cash flow is lost due to the reduced depreciation from $46,000 to $12,000?
Cash flow ________________________
2. The Short-Line Railroad is considering a $115,000 investment in either of two companies. The cash flows are as follows:
Year Electric Co. Water Works
1 $ 95,000 $10,000
2 10,000 10,000
3 10,000 95,000
XXXXXXXXXX,000 10,000
Compute the payback period for both companies.
Electric Co. _______________years
Water Works _____________years
Which of the investments is superior from the information provided?
Electric Co ________________
Water Works _____________
3. X-tree Vitamin Company is considering two investments, both of which cost $47,000. The cash flows are as follows:
Year Project A Project B
1 $50,000 $47,000
2 20, XXXXXXXXXX,000
3 18, XXXXXXXXXX,000
Calculate the payback period for Project A and Project B
Project A ______________year
Project B ______________year
Which of the two projects should be chosen based on the payback method?
Project A _______
Project B________
Calculate the net present value for Project A and Project B. Assume a cost of capital of 8%
Project A ___________ (Net Present Value)
Project B ___________ (Net Present Value)
Which of the two projects should be chosen based on the net present value method?
Project A ________
Project B ________
Should a firm normally have more confidence in the payback method or the net present value method?
Net present value method _______
Payback method _______
4. You buy a new piece of equipment for $14,761, and you receive a cash inflow of $2,300 per year for 10 years.
What is the internal rate of return?
Internal rate of return _______________%
5. Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $90,000. The annual cash inflows for the next three years will be:
Year Cash Flow
1 $40,000
2 38,000
3 30,000
Determine the internal rate of return.
Internal rate of return __________%
With a cost of capital of 12%, should the equipment be purchased? Yes________ No ________
6. The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $69,000. The annual cash flows have the following projections.
Year Cash flow
1 $29,000
2 29,000
3 29,000
4 34,000
5 20,000
If the cost of capital is 13% what is the net present value of selecting a new machine?
Net Present Value __________
What is the internal rate of return? ___________________
Should the project be accepted? Yes _______________ No______________
7. Turner Video will invest $94,500 in a project. The firmâ€™s cost of capital is 10%. The investment will provide the following inflows.
Year Inflow
1 $33,000
2 35,000
3 32,000
4 38,000
5 45,000
The internal rate of return is 15%.
If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years?
Total value of inflows ____________
If the reinvestment assumption of the internal rate of return method is used, what will be the total value of the inflows after five years?
Total value of inflows ____________
Which investment assumption is better?
Reinvestment assumption IRR
Reinvestment assumption NPV
8. Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic life. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:
Project E Project H
($52, XXXXXXXXXX,000)
Year Cash Flow Year Cash Flow
1 $10,000 1 $27,000
2 14, XXXXXXXXXX,000
3 24, XXXXXXXXXX,000
XXXXXXXXXX
Determine the net present value of the projects based on zero percent discount rate.
Project E _____________
Project H _____________
Determine the net present value of the projects based on a discount rate on 9%
Project E _____________
Project H _____________
If the projects are not mutually exclusive, which projects would you accept if the discount rate is 9%?
Project E ____________
Project H ___________
Both H & E _________
9. Telstar Communications is going to purchase an asset for $720,000 that will produce $350,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three-year MACRS depreciation schedule. The firm is in a 35% tax bracket.
Fill in the schedule below for the next four years.
| Year 1 | Year 2 | Year 3 | Year 4 |
Earnings before depreciation and taxes | | | | |
Depreciation | | | | |
Earnings before taxes | | | | |
Taxes | | | | |
Earnings after Taxes | | | | |
Depreciation | | | | |
Cash Flow | | | | |
10. The Summit Petroleum Corp. will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $240,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years:
Year 1 $110,000
Year 2 137,000
Year 3 54,000
Year 4 52,000
The firm is in a 30% tax bracket and has a cost of capital of 5 percent.
Calculate the net present value.
Net present value ____________
Under the net present value method, should Summit Petroleum Corporation purchase the asset?
Yes __________
No __________
11. An asset was purchased three years ago for $115,000. It falls into the five-year category for MACRS depreciation. The firm is in a 30% tax bracket.
Compute the tax loss on the sale and the related tax benefit if the asset is sold now for $14,560
Tax loss on the sale ___________
Tax benefit ______________
Compute the gain and related tax on the sale if the asset is sold now for $55,060.
Taxable gain ____________
Tax obligation ______________
12. DataPoint Engineering is considering the purchase of a new piece of equipment for $420,000. It has an eight-year mid-point of its asset depreciation range (ADR). It will require an additional initial investment of $240,000 in non-depreciable working capital. Eighty thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table.
Year Amount
1 $239,000
2 196,000
3 166,000
4 151,000
5 113,000
6 103,000
The tax rate is 40%. The cost of capital must be computed based on the following:
Cost Weights
Debt K_{d} 11.20% 35%
Preferred stock K_{p} XXXXXXXXXX
Common equity (retained earnings) K_{e} XXXXXXXXXX
Determine the annual depreciation schedule.
Year | Depreciation Base | Percentage Depreciation | Annual Depreciation |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
Determine the annual cash flow for each year. Be sure to include the recovered working capital in in Year 6.
Determine the weighted average cost of capital
Weight average cost of capital _________________%
Determine the new present value.
Net present value ______________________
Should DataPoint purchase the new equipment?
Yes ______________ No _______________
13. Hercules Exercise Equipment Co purchased a computerize measuring device two year ago for $62,000. The equipment falls into the five-year category for MACRS depreciation and can sold for $26,8000. New piece of equipment will cost $152,000. It also falls into the five-year category for MACRS depreciation. Assume the new equipment would provide the following stream of added cost savings for the next six years.
Year Cash Savings
1 $64,000
2 56,000
3 54,000
4 52,000
5 49,000
6 38,000
The firmâ€™s tax rate is 30% and the old equipment?
What is the book value of the old equipment? What is the tax loss on the sale of the old equipment?
What is the tax benefit from the sale? What is the cash inflow from the sale of the old equipment?
What is the net cost of the new equipment? Determine the depreciation schedule for the new equipment.
Determine the depreciation schedule for the remaining years of the old equipment. Determine the incremental depreciation between the old and new equipment and the related tax shield benefit.
Compute the aftertax benefits of the cost savings. Add the depreciation tax shield benefits and the aftertax cost savings to determine the total annual benefits.
Compute the present value of the value of the total annual benefits. Compare the present value of the incremental benefits to the new cost of the new equipment.
Should the replacement be undertaken? Yes ______________ No ________________
14. Assume you risk-averse and have the following three choices.
Expected Standard
Value Deviation
A $1,940 $ 1,280
B 2,770 1,540
C 1,950 1,320
Which project will you select?
Project A __________ Project B___________ Project C ___________
15. Myers Business systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are give next:
Possible
Market Reaction Sales in Units Probabilities
Low response 35 .20
Moderate response 45 .20
High response 60 .30
Very high response 70 .30
What is the expected value of unit sales for the new product? Expected value ___________
What is the standard deviation of unit sales? Standard deviation ____________
16. Shack Homebuilders Limited is evaluating a new promotion campaign that could increase home sales. Possible outcomes and probabilities of the outcomes are shown next.
Additional
Possible Outcomes Sales in Units Probabilities
Ineffective campaign XXXXXXXXXX
Normal response XXXXXXXXXX
Extremely Effective XXXXXXXXXX
Compute the coefficient of variation.
Coefficient of variation ____________
17. Five investment alternatives have the following returns and standard deviation of returns.
Returns: Standard
Alternatives Expected Value Deviation
A $ 1,940 $ 1,180
B XXXXXXXXXX
C 13,100 2,600
D 1,840 1,020
E 68,100 16,200
Calculate the coefficient of variation and rank the five alternatives from lowest risk to highest risk by using the coefficient of variation.
Alternative | Coefficient of Variation | Rank |
A | | |
B | | |
C | | |
D | | |
E | | |
18. Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.
Returns: Standard
Investments Expected Value Deviation
Buy Stocks $ 9,010 $ 6,470
Buy bonds 7,030 2,460
Buy commodity futures 26,800 23,900
Buy Options 21,200 21,500
| Coefficient of Variation |
Buy Stocks | |
Buy bonds | |
Buy commodity | |
Buy Options | |
Which one of the following four investments should Tim choose?
Buy Bonds_____________ Buy Stocks ______________
Buy Commodity futures ___________ Buy Options ___________
Which one of the four investments should Mike choose?
Buy Bonds ______________ Buy Stocks _______________
Buy Commodity ____________ Buy Options ______________
19. Mountain Ski Corp was set up to take large risks and is willing to take the greatest risk possible. Lakeway Train Co. is more typical of the average corporation and is risk-averse.
Returns: Standard
Projects Expected Value Deviation
A $268,000 $225,000
B 756, XXXXXXXXXX,000
C 169, XXXXXXXXXX,000
D 162, XXXXXXXXXX,000
Compute the coefficients of variation.
| Coefficient of Variation |
Project A | |
Project B | |
Project C | |
Project D | |
Which projects should Mountain Ski Corp choose?
Project A__________ Project C__________
Project B__________ Project D__________
Which one of the four projects should Lakeway Train Co. choose based on the same criteria of using the coefficient of variation?
Project A __________ Project C ___________
Project B __________ Project D ___________
20. Waste Industries is evaluating a $51,300 project with the following cash flows.
Years Cash flows
1 $9,000
2 20,900
3 23,500
4 16,300
5 24,300
The coefficient of variation for the project is .945
Coefficient of
Variation Discount Rate
XXXXXXXXXX%
XXXXXXXXXX%
XXXXXXXXXX%
XXXXXXXXXX%
1.01 â€“ XXXXXXXXXX%
Select the appropriate discount rate.
_____6% _____8% _____12% _____16% _____20%
Compute the net present value.
Net present value __________
Based on the net present value should be the project be undertaken? Yes ______ No ______
21. Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 13% discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 17%. Either method will require an initial capital outlay of $100,000. The inflows from projected business over the next five years are shown next.
Years Method 1 Method 2
1 $29,200 19,700
2 33,200 28,400
3 41,100 36,500
4 32,400 36,000
5 24,600 71,100
Calculate net present value for Method 1 and Method 2
| Net Present Value |
Method 1 | |
Method 2 | |
Which method should be selected using net present value analysis?
_____Method 1 _____Method 2 _____neither of these
22. Debbyâ€™s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $15,500. Debby is not sure how many members the new equipment will attract, but the estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debbyâ€™s cost of capital is 14%.
Cash Flow Probability
$4,480 .3
5,850 .3
8,340 .2
9,900 .2
What is the expected value of the cash flow? The value you compute will apply to each of the five years.
Expected cash flow _____________
What is the expected net present value?
Net present value ______________
Should Debby buy the new equipment?
No _________ Yes __________
23. Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,677,000 and will produce $385,000 per year in years 5 through 15 and $529,000 per year in years 16 through 25. The U.S. gold mine will cost $2,036,000 and will produce $299,000 per year for the next 25 years. The cost of capital is 7%.
| Net Present Value |
The Australian Mine | |
The U.S. mine | |
Which investment should be made?
_____Australian mine
_____U.S. mine
Assume the Australian mine justifies an extra 5% premium over the normal cost of capital because of its riskiness and relative uncertainty of cash flows. Calculate the new net present value given this assumption
| Net Present Value |
The Australian mine | |
Does the new assumption change the investment decision?
Yes ___________ No____________