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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...

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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 firm’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 Kd 11.20% 35%

Preferred stock Kp XXXXXXXXXX

Common equity (retained earnings) Ke 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.

Year

Cash flow

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 firm’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 – 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. Debby’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. Debby’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____________

Answered Same Day Jun 29, 2020

Solution

Aarti J answered on Jul 02 2020
140 Votes
Sheet1
    1    Earnings before depreciation    118000
        Depreciation    46000
        Earnings before taxes    72000
        Taxes    28800
        Earnings after taxes    43200
        Depreciation    46000
        Cash flow    89200
        How much would cash flow be if there were only $12,000 in depreciation? All other factors are the same
        Earnings before depreciation    118000
        Depreciation    12000
        Earnings before taxes    106000
        Taxes    42400
        Earnings after taxes    63600
        Depreciation    12000
        Cash flow    75600
        Cash flow lost    13600
    2    year    Electric    Water works    Cumulative - Electric    Cumulative - Wate
        0    -115000    -115000    -115000    -115000
        1    95000    10000    -20000    -105000
        2    10000    10000    -10000    -95000
        3    10000    95000    0    0
        4    10000    10000    10000    10000
        5    10000    10000    20000    20000
        6    10000    10000    30000    30000
        7    10000    10000    40000    40000
        8    10000    10000    50000    50000
        9    10000    10000    60000    60000
        10    10000    10000    70000    70000
        Payback
        Electric    3    yrs
        Water workds    3    yrs
        Electric is superior from the information provided
    3    year    A    B    Cumulative - Electric    Cumulative - Wate
        0    -47000    -47000    -47000    -47000
        1    50000    47000    3000    0
        2    20000    19000    23000    19000
        3    18000    25000    41000    44000
        Payback    0.94    1    yrs
        Project A should be chosen
        Calculate NPV
        year    A    B    PVIF @ 8%    PV - A    PV - B
        0    -47000    -47000    1    -47000    -47000
        1    50000    47000    0.9259259259    46296.2962962963    43518.5185185185
        2    20000    19000    0.8573388203    17146.7764060357    16289.4375857339
        3    18000    25000    0.793832241    14288.9803383631    19845.8060255042
            A    B
        NPV =
        Present value of the cash flows    77732.053040695    79653.7621297566
        Less: Initial investment    -47000    -47000
        NPV    30732.053040695    32653.7621297566
        Project B should be chosen
        Should a firm normally have more confidence in the payback method or the net present value method
        NPV value method is more reliable
    4    year    cash flows
        0    -14761
        1    2300
        2    2300
        3    2300
        4    2300
        5    2300
        6    2300
        7    2300
        8    2300
        9    2300
        10    2300
        Using excel formula, calculating the IRR
        IRR =    9.00%
    5    year    Cash flows
        0    -90000
        1    40000
        2    38000
        3    30000
        IRR =    10.20%
        No, if the cost of capital is 12%, the equipment should not be purchased
    6    year    Cash flows
        0    -69000
        1    29000
        2    29000
        3    29000
        4    34000
        5    20000
        Using excel formulas
        NPV    $ 31,181.46
        IRR    30.74%
        The project must be accepted
    7    year    Cash flows    FVIF @ 10%    FVIF @ 15%    FV - 10%    FV - 15%
            -94500
        4    33000    1.4641    1.74900625    48315.3    57717.20625
        3    35000    1.331    1.520875    46585    53230.625
        2    32000    1.21    1.3225    38720    42320
        1    38000    1.1    1.15    41800    43700
        0    45000    1    1    45000    45000
        If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years
        Cash inflow =    $ 220,420.30
        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
        Cash inflow =    $ 241,967.83
        Reinvestment assumption...
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