Project 4 Workbook answer and calculations
Instructions Answer all questions in this workbook. Be sure to read the introductory text on tabs 1 and 3 as well as these instructions. Keep in mind that the focus of this project is corporate finance. The information generated by the accounting system is important; but in finance, decisions are driven by an analysis of cash flows rather than profits. Tab 1 contains a series of exercises on the concept of the time value of money. These exercises do not relate directly to the issues facing LGI. Tab 2 focuses on the concept of annuities. The first few questions do not pertain specifically to LGI; the latter questions do. Tab 3 pertains to whether LGI should acquire new assets that may enhance the company’s productivity and thus improve financial performance. 061523 Time value of money (TVM) exercises There are five variables in TVM calculations: present value, number of periods, rate of return, regular payments, and future value. If four of the variables are known, then the fifth can be calculated using algebra, a financial calculator, or a computer program such as Excel. Excel functions for the five variables are as follows: • • • • • PV—present value NPER—number of periods RATE—rate of return PMT—regular payments FV—future value 1. Briefly explain the meaning of the term “present value” in your own words. 2. Briefly explain the meaning of the term “future value” in your own words. 3. What is the future value in five years of $1,500 invested at an interest rate of 4.95%? 4. What is the future value of a single payment with the following characteristics? PV $950 NPER 6 years RATE 5.4% 5. What is the present value of $65,000 in six years, if the relevant interest rate is 8.1%? 6. What is the present value of a single payment with the following characteristics? NPER 11 years RATE 5.05% FV $10,000 7. The present value of a payment is $4000. The future value of that payment in five years will be $4800. What is 8. What is the annual rate of return of a single payment with the following characteristics? PV $1,000 NPER 15 years FV $10,000 011022 Tab 2 – Annuities 1. How many years would be required to pay off a loan with the following characteristics? PV $11,500 RATE 10.6% PMT $1,600 (annual payments) 2. What is the annual payment required to pay off a loan with the following characteristics? PV $14,700 RATE 9.95% NPER 10 years 3. Why is FV not part of the calculations for either question 1 or question 2? 4. At what annual rate of interest is a loan with the following characteristics? NPER PMT PV 17 years $100,000 $1,000,000 For questions 5-8, LGI’s cost of capital is 8.11% 5. LGI projects the following after-tax cash flows from operations from its aging Bowie, Maryland distribution facility (which first went on line in 1953) over the next five years. What is the PV of these cash flows? Year Projected after-tax cash flows (in $ millions) 1 (40) 2 (40) 3 (40) 4 (40) 5 (40) 6. LGI extended the analysis out for an additional 7 years, and generated the following projections. What is the PV of these cash flows? Projected after-tax cash flows Year (in $ millions) 1 (40) 2 (40) 3 (40) 4 (40) 5 (40) 6 (40) 7 (40) 8 (40) 9 (40) 10 (40) 11 (40) 12 (40) 7. The CFO asked you to undertake a more detailed analysis of the plant’s costs, noting that while it is convenient for making calculations when projections result in data that can be treated like an annuity, this does not always represent the most accurate estimate of future results. What is the PV of these cash flows? Year Projected after-tax cash flows (in $ millions) 1 (40) 2 (50) 3 (55) 4 (60) 5 (70) 8. As part of a larger plan to sell off underperforming assets, LGI is considering selling the Bowie property and using other existing facilities more efficiently. LGI received four preliminary offers from potential buyers for th property. What is the PV of each offer? PV of each offer (in $ millions) Offer A Offer B Offer C Offer D $102.17 million, paid today $19.85 million per year, to be paid over the next 8 years $201.88 million, to be paid in year 8 $18.09 million per year, to be paid over the next 7 years and a $53.05 million payment in year 8 9. From a profit maximizing point of view, which offer should LGI accept? 10. Define the term annuity in your own words. How might the concept of an annuity impact the process of capital budgeting and new asset acquisition? 011022 Robotics-based equipment proposal If the Bowie plant is sold, those operations will need to shift to the main Largo facility. The CEO sorting and distribution equipment to facilitate more cost-effective operations (and be able to handle the increase The CFO has asked you to evaluate the cash flow projections associated with the equipment purchase proposal an the purchase should go forward. Table 2 shows projections of the cash inflows and outflows that would occur duri using the new equipment. Keep the following in mind: • • Depreciation. The equipment will be depreciated using the straight-line method over eight years. The projec Taxes. The CFO estimates that company operations as a whole will be profitable on an ongoing basis. As a re on this specific project will provide a tax benefit in the year of the loss. Table 1 – Data Cost of the new manfactoring equipment (at year=0) $ Corporate income tax rate – Federal Corporate income tax rate – State of Maryland Discount rate for the project 191.1 26.0% 8.0% 5.98% Table 2 – After-tax Cash Flow Timeline Year minus minus equals (all figures in $ millions) Projected Cash Projected Cash Inflows from Outflows from Depreciation Operations Operations Expense 0 1 850.0 840.0 2 900.0 810.0 3 990.0 870.0 4 1,005.0 900.0 5 1,200.0 1,100.0 6 1,300.0 1,150.0 7 1,350.0 1,300.0 8 1,320.0 1,300.0 Projected Taxable Income Table 3 – Example – Computing Projected After-tax Cas For Year 4 (all figures in $ millions) Projected Cash Inflows from Operations 1005.0 Projected Cash Outflows from Operations (900.0) Depreciation Expense (23.9) Projected Taxable Income 81.1 times equals Projected Taxable Income Corporate income tax rate – Federal Projected Federal Income Taxes 81.1 26.0% 21.1 times equals Projected Taxable Income Corporate income tax rate – State Projected State Income Taxes 81.1 8.0% 6.5 1. Complete Table 2. Compute the projected after tax cash flows for each of years 1-8. 2. Compute the total present value (PV) of the projected after tax cash flows for years 1-8. 3. Compute the net present value (NPV) of the projected after tax cash flows for years 0-8. 4. Compute the internal rate of return (IRR) of the project. 5. The CFO believes that it is possible that the next few years will bring a very low interest rate environment. Therefore, she has asked that you repeat the NPV calculation in question 3 showing the case where the discount rate for the project is 5.02% 011022 acility. The CEO is proposing to acquire robotics-based and be able to handle the increased workload) at Largo. e equipment purchase proposal and recommend whether nd outflows that would occur during the first eight years ethod over eight years. The projected salvage value is $0. itable on an ongoing basis. As a result, any accounting loss million Projected Federal Income Taxes Projected State Income Taxes Projected After-tax Cash Flows uting Projected After-tax Cash Flows minus minus equals Projected Cash Inflows from Operations Projected Cash Outflows from Operations Projected Federal Income Taxes Projected State Income Taxes 1005.0 (900.0) (21.1) (6.5) w interest rate environment. ing the case where the Projected After-tax Cash Flows 77.4
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