BAFI 355

BUSS207

Fall, 2019

Assignment 4

(Due by Dec. 11, 2019)

Please solve the following questions. If you prefer to work in a group in completing this assignment, you

may do so. Groups are limited to a maximum size of 3 students. If you work in a group, the group will

turn in one solution to the assignment and everyone in the group will receive the same grade on the

assignment. If you work in a group, please make sure that you write down the names of all of your group

members. If more than one group works together and turns in, substantially, the same work, this violates

the rules of the course and the rules on academic integrity, and penalties will be assessed. The assignment

is due at the beginning of class on the due date. Please show all the intermediate steps and calculations

when solving the problems and state your assumptions (if any). Please type your answers.

1. Reserve Inc. is considering a project that will result in initial after-tax cash savings of

$6 million at the end of the first year, and these savings will grow at a rate of 3

percent per year indefinitely. The firm has a target debt-equity ratio of 0.70, a cost of

equity of 16 percent, and an after-tax cost of debt of 6 percent. The cost-saving

proposal is somewhat riskier than the usual project the firm undertakes; management

uses the subjective approach and applies an adjustment factor of +2 percent to the

cost of capital for such risky projects (meaning that the cost of capital for the project

should be higher than the cost of capital for the firm by 2 percent). Under what

circumstances should this Reserve Inc. take on the project?

2. BAFI Inc., imposes a payback cutoff of three years for its international investment

projects. If the company has the following two projects available, should they accept

either of them? (To answer this question, please apply both payback period and

discounted payback period assuming the discount rate of 6%)

Year Cash Flow (A) Cash Flow (B)

0 -$50,000 -$70,000

1 30,000 8,000

2 15,000 20,000

3 10,000 30,000

4 10,000 500,000

3. Consider the following cash flows. Using MIRR with 8% discount rate, should we

take this project?

Year Cash Flow

0 -504

1 2,862

2 -6,070

3 5,700

4 -1,000

4. The ABC Inc., wants to set up a private cemetery business. According to the CFO,

John Smith, business is “looking up”. As a result, the cemetery project will provide a

net cash inflow of $40,000 for the firm during the first year, and the cash flows are

projected to grow at a rate of 7 percent per year forever. The project requires an

initial investment of $650,000. If ABC Inc., requires a 14 percent return on such

undertakings, should the cemetery business be started?

5. Suppose you have been hired as a financial consultant to ABC Inc., a large, publicly

traded firm that is the market share leader in radar detection systems (RDSs). The

company is looking at setting up a manufacturing plant overseas to produce a new

line of RDSs. This will be a five-year project. The company bought some land three

years ago for $6 million in anticipation of using it as a toxic dump site for waste

chemicals, but it built a piping system to safely discard the chemicals instead. The

land was appraised last week for $9.25 million. The company wants to build its new

manufacturing plant on this land; the plant will cost $14 million to build. The

following market data on ABC Inc.’s securities are cu

ent:

Debt: 10,000 8 percent coupon bond outstanding, 15 years to maturity, selling for 92

percent pf par; the bonds have a $1,000 par value each and make semiannual

payments.

Common stock: 250,000 shares outstanding, selling for $70 per share; the beta is 1.4

Market Information: 8 percent expected market risk premium; 5 percent risk-free rate

ABC Inc. has enough internally generated funds and has been advised to fund the

entire project using the internally generated funds only. ABC Inc.’s tax rate is 35

percent. The project requires $900,000 in initial investment to get operational.

A. Calculate the project’s initial Time 0 cash flow, taking into account all side effects.

B. The new RDS project is somewhat riskier than a typical project for ABC, primarily

ecause the plant is being located overseas. Management has told you to use an

adjustment factor of +2 percent to account for this increased riskiness. Calculate the

appropriate discount rate to use when evaluating ABC’s project.

C. The manufacturing plant has a five-year useful life, and ABC uses straight-line

depreciation. At the end of the project (i.e., the end of year 5), the plant can be

scrapped for $5 million. What is the annual depreciation of this plant?

D. The company will incur $350,000 in annual fixed costs. The plan is to manufacture

10,000 RDSs per year and sell them at $10,400 per machine; the variable production

costs are $8,500 per RDS. What is the annual operating cash flow, OCF, from this

project?

E. Finally, ABC’s president wants you to throw all your calculations, assumptions, and

everything else into the report for the chief financial officer; all he wants to know is

what the RDS project’s IRR and NPV are. What will you report?

BUSS207

Fall, 2019

Assignment 4

(Due by Dec. 11, 2019)

Please solve the following questions. If you prefer to work in a group in completing this assignment, you

may do so. Groups are limited to a maximum size of 3 students. If you work in a group, the group will

turn in one solution to the assignment and everyone in the group will receive the same grade on the

assignment. If you work in a group, please make sure that you write down the names of all of your group

members. If more than one group works together and turns in, substantially, the same work, this violates

the rules of the course and the rules on academic integrity, and penalties will be assessed. The assignment

is due at the beginning of class on the due date. Please show all the intermediate steps and calculations

when solving the problems and state your assumptions (if any). Please type your answers.

1. Reserve Inc. is considering a project that will result in initial after-tax cash savings of

$6 million at the end of the first year, and these savings will grow at a rate of 3

percent per year indefinitely. The firm has a target debt-equity ratio of 0.70, a cost of

equity of 16 percent, and an after-tax cost of debt of 6 percent. The cost-saving

proposal is somewhat riskier than the usual project the firm undertakes; management

uses the subjective approach and applies an adjustment factor of +2 percent to the

cost of capital for such risky projects (meaning that the cost of capital for the project

should be higher than the cost of capital for the firm by 2 percent). Under what

circumstances should this Reserve Inc. take on the project?

2. BAFI Inc., imposes a payback cutoff of three years for its international investment

projects. If the company has the following two projects available, should they accept

either of them? (To answer this question, please apply both payback period and

discounted payback period assuming the discount rate of 6%)

Year Cash Flow (A) Cash Flow (B)

0 -$50,000 -$70,000

1 30,000 8,000

2 15,000 20,000

3 10,000 30,000

4 10,000 500,000

3. Consider the following cash flows. Using MIRR with 8% discount rate, should we

take this project?

Year Cash Flow

0 -504

1 2,862

2 -6,070

3 5,700

4 -1,000

4. The ABC Inc., wants to set up a private cemetery business. According to the CFO,

John Smith, business is “looking up”. As a result, the cemetery project will provide a

net cash inflow of $40,000 for the firm during the first year, and the cash flows are

projected to grow at a rate of 7 percent per year forever. The project requires an

initial investment of $650,000. If ABC Inc., requires a 14 percent return on such

undertakings, should the cemetery business be started?

5. Suppose you have been hired as a financial consultant to ABC Inc., a large, publicly

traded firm that is the market share leader in radar detection systems (RDSs). The

company is looking at setting up a manufacturing plant overseas to produce a new

line of RDSs. This will be a five-year project. The company bought some land three

years ago for $6 million in anticipation of using it as a toxic dump site for waste

chemicals, but it built a piping system to safely discard the chemicals instead. The

land was appraised last week for $9.25 million. The company wants to build its new

manufacturing plant on this land; the plant will cost $14 million to build. The

following market data on ABC Inc.’s securities are cu

ent:

Debt: 10,000 8 percent coupon bond outstanding, 15 years to maturity, selling for 92

percent pf par; the bonds have a $1,000 par value each and make semiannual

payments.

Common stock: 250,000 shares outstanding, selling for $70 per share; the beta is 1.4

Market Information: 8 percent expected market risk premium; 5 percent risk-free rate

ABC Inc. has enough internally generated funds and has been advised to fund the

entire project using the internally generated funds only. ABC Inc.’s tax rate is 35

percent. The project requires $900,000 in initial investment to get operational.

A. Calculate the project’s initial Time 0 cash flow, taking into account all side effects.

B. The new RDS project is somewhat riskier than a typical project for ABC, primarily

ecause the plant is being located overseas. Management has told you to use an

adjustment factor of +2 percent to account for this increased riskiness. Calculate the

appropriate discount rate to use when evaluating ABC’s project.

C. The manufacturing plant has a five-year useful life, and ABC uses straight-line

depreciation. At the end of the project (i.e., the end of year 5), the plant can be

scrapped for $5 million. What is the annual depreciation of this plant?

D. The company will incur $350,000 in annual fixed costs. The plan is to manufacture

10,000 RDSs per year and sell them at $10,400 per machine; the variable production

costs are $8,500 per RDS. What is the annual operating cash flow, OCF, from this

project?

E. Finally, ABC’s president wants you to throw all your calculations, assumptions, and

everything else into the report for the chief financial officer; all he wants to know is

what the RDS project’s IRR and NPV are. What will you report?

Answered Same DayDec 02, 2021

Ques 1

Calculation of WACC

Particula

Weight

Cost

Weighted cost

Equity

0.3

16%

0.048

Debt

0.7

6%

0.042

0.09

weighted cost of capital

9%

If nothing is given WACC can be taken as the base for selection of project.

For higher riskier project the 2% risk will be added so the rate of profit should be more than 11% (9+2).

Ques 2

Project A

Yea

Cash flow

PV

0

-50000

1

-50000

-50000

1

30000

0.943396

28301.89

-21698.1

2

15000

0.889996

13349.95

-8348.17

3

10000

0.839619

8396.193

48.02622

4

10000

0.792094

7920.937

7968.963

7968.963

payback period 3 years

Project B

Yea

Cash...

Calculation of WACC

Particula

Weight

Cost

Weighted cost

Equity

0.3

16%

0.048

Debt

0.7

6%

0.042

0.09

weighted cost of capital

9%

If nothing is given WACC can be taken as the base for selection of project.

For higher riskier project the 2% risk will be added so the rate of profit should be more than 11% (9+2).

Ques 2

Project A

Yea

Cash flow

PV

0

-50000

1

-50000

-50000

1

30000

0.943396

28301.89

-21698.1

2

15000

0.889996

13349.95

-8348.17

3

10000

0.839619

8396.193

48.02622

4

10000

0.792094

7920.937

7968.963

7968.963

payback period 3 years

Project B

Yea

Cash...

SOLUTION.PDF## Answer To This Question Is Available To Download

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