Foley Systems is considering a new investment whose data are shown below. The equipment would be depreciated on a straight-line basis
Please answer the following questions.
Make sure that you show your work.
1. Foley Systems is considering a new investment whose data are shown below. The equipment would be depreciated on a straight-line basis
over the project’s 3-year life, would have a zero-salvage value, and would require some additional working capital that would be recovered
at the end of the project’s life. Revenues and other operating costs are expected to be constant over the project’s life.
What is the project’s NPV? (Hint: Cash flows are constant in Years 1 to 3.)
WACC 10.0%
Net investment in fixed assets (basis) $75,000
Required new working capital $15,000
Straight-line deprec. rate 33.333%
Sales revenues, each year $75,000
Operating costs (excl. deprec.), each year $25,000
Tax rate 35.0%
2. NBM has $2 million of extra cash. It has two choices to make use of the cash. One alternative is to invest the cash in financial assets.
The resulted investment income will be paid out as a special dividend at the end of three years.
In this case, the firm can invest in Treasury bills yielding 7%, or an 11% preferred stock.
The tax law says only 30% of the dividend from the preferred stock investment would be subject to the corporate income tax.
Another alternative is to pay out the cash as dividends and let the shareholders invest on their own in T-bills with the same yield.
The corporate tax rate is 35%, and the individual tax rate is 31%.
Should the cash be paid today or in three years?
Which of the two options generates the highest after-tax income for shareholders?
3. XYZ Corporation is planning to raise an additional $30 million in capital, either via 240,000 shares of common stock at $125 per share net proceeds, or via 300,000 shares of 9% percent preferred stock.
Current earnings are $12.50 per share on one million shares outstanding. $2,500,000 is paid annually on existing debt, and dividends on existing preferred stock amount to $1,500,000 per year.
The current market price of common stock is $140 per share.
The firm has a dividend policy of paying $8 per share on common stock which it intends to keep. Assume a tax rate of 46%.
• What is the least amount of incremental earnings from the planned expansion required to meet the incremental cost of capital from either source?
• What is the breakeven EBIT for both sources of capital?
4. TexMex Food Company is considering a new salsa whose data are shown below.
The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero-salvage value,
and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life.
However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows.
What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)
WACC 10.0%
Pre-tax Cash Flow Reduction for Other Products (cannibalization) $5,000
Investment Cost (depreciable basis) $80,000
Straight-line Depreciation Rate 33.333%
Depreciation Per Year $26,667
Sales Revenues Per Year $67,500
Annual Operating Costs Excluding Depreciation $25,000
Tax rate 35.0%
5. Union America Corporation (UAC) is planning to bid on a project to supply 150,000 cartons of machine screws per year for 5 years to the US Navy.
In order to produce the machine screws UAC would have to buy some new equipment.
The new equipment would cost $780,000 to purchase and install.
This equipment would be depreciated straight line to zero over the five years of the contract.
However, UAC thinks it could sell the equipment for $50,000 at the end of year 5.
Fixed production costs will be $240,000 per year, and variable costs of production are $8.50 per carton.
UAC would also need an initial investment in Net Working Capital of $75,000 at the beginning of this project.
UAC has a cost of capital of 16% and a tax rate of 35%.
What should be the bid price per carton on this project?
6. Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years.
The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life.
It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them.
The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year.
The firm’s tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases.
What is the net advantage to leasing (NAL), in thousands?
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