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26. Your firm is considering a 3-year project. Initial investment is $2 million. This does not include incremental working capital needs of $250,000 which will be returned at the project’s end. Project operating cash flow will be $850,000 in each of the three years. In the final year, the project is also expected to produce a $50,000 cash flow from salvage. The project has “average” risk and your company’s WACC (adjusted for taxes) is 14%. What is the NPV? ,,What are the “Net Cash Flows” for each year (2.5 points):,,Year 0 1 2 3,Net Cash Flows ,,,NPV (2 points) = ,,,,,27. Consider two companies that are alike except in borrowing choices. Company 1 has no debt financing, and Company 2 uses debt financing. The EBIT for both companies is $800. Company 1 has 400 shares outstanding and pays no interest. Company 2 has 300 shares outstanding and pays $250 in interest. What is the EPS for each company?,,EPS Company 1 =,,EPS Company 2 =,,,,28. Donat Corp. is a small company looking at two possible capital structures. Currently, the firm is an all-equity firm with $600,000 in assets and 100,000 shares outstanding. The market value of each share is $6.00. The CEO of Donat is thinking of leveraging the firm by selling $300,000 of debt financing and retiring 50,000 shares, leaving 50,000 shares outstanding. The cost of debt is 5% annually, and the current corporate tax rate for Donat is 30%. The CEO believes that Donat will earn $50,000 per year before interest and taxes. What is the Earnings Per Share (EPS) under each scenario? ,,All-Equity EPS = ,,50/50 Debt-to-Equity EPS = ,.,,29. Fuji Inc. is registered as a business in the film-making industry. Its debt consists of bonds which have a coupon interest rate of 6% and have a yield to maturity (YTM) of 9%. Its cost of equity with 50% debt is 12%. Its corporate tax rate is 30%. If the M&M world of taxes holds, what is the WACC for Fuji with 50% debt financing?,,WACC = ,,,30. Western Equipment Company will issue 30-year, semiannual bonds with an 8.0% coupon rate and a $1,000 par value. Bonds of similar risk and maturity are currently selling to yield 7.0% in the market place. What is the market price of one of the firm’s new bonds? ,,31. Phillip Enterprises Inc. needs to determine its cost of equity capital. Use the following information to estimate the firm’s cost of equity using both the security market line and the dividend growth model. The current market price of stock is $22.89, the risk-free rate is 4.00%, the required return on the market portfolio is 13.50%, the firm has a constant growth rate in dividends of 3.00% per year, current dividends are $2.00, and the firm’s beta is 0.90.,,Price of the Stock using:,Dividend Growth Model = ,,SML (CAPM) = ,,32. ACME Industries has two mutually exclusive projects to choose from: Project A costs $60,000 and produces positive cash flows of $20,000 at the end of each of the next four years. Project B costs $70,000 and produces cash flows of $30,000 at the end of the next three years. If the discount rate for each is 10%, what would be the Equivalent Annual Cost (EAC) for each (NPV/PVannuity factor)? Which is superior?,, NPV @ 10% PROJECT A: ,, NPV @10% PROJECT B,,EAC project A =,,EAC Project B = ,,33. If you plan to start saving for retirement and can save $500 per month for the next 30 years (at which time you will be 65) how much money will you have if the investment firm promises a 6% return (APR) compounded monthly? ,,Value of retirement account at age 65 = ,,,34. You win the lottery and are offered $100,000 per year for 20 years or a lump sum of $1 million. You can invest money safely for 8% and this is the appropriate discount rate also. ,Which is the better offer on financial grounds (ignore taxes etc)? ,On what basis are you comparing the offers?,,What are your results? ,,,,35. Investors Al and Bea lend $100,000 to each new idea. Al’s history is that he selects low-risk projects or ideas that hit 50% of the time. Bea’s history is that she takes on high-risk projects that hit 20% of the time. What rate of return must each successful project pay Al and Bea for them to break even?,,Al’s breakeven rate of return:,Bea’s breakeven rate of return:,