Posted: September 13th, 2017

Assignment

Paper, Order, or Assignment Requirements

 

 

I’ll upload a document about the finance problems.

Question 1

Capital Budgeting

1 )

ABC Company is evaluating several different (independent) development projects for experimental drugs. Although the cash flows are difficult to forecast, the company has come up with the following estimates of the initial capital requirements and NPV for the projects.

 

Project Number	Initial Capital $M)	NPV ($M)
1	10	10.10
2	15	19.00
3	15	22.00
4	20	25.00
5	30	60.20

 

(a) If there is no capital rationing in place, which project(s) should be chosen? Explain your answer.

(b) Suppose now that ABC has a total capital budget of $60 million. On this basis, which project(s) should be chosen? Explain your answer.

2 )

• A company is considering two mutually exclusive projects, A and B, each requiring an up-front outlay of $1 million. The expected future cash flows associated with each of the projects (stated in nominal terms), along with annual expected inflation rates, are contained in the following table.

$000	Y1	Y2	Y3	Y4
Project A	400	250	600	300
Project B	0	100	800	950
Inflation	5%	5%	4%	3%

 

The company’s real cost of capital is 12%. Calculate the NPV of each of the projects and advise the company of the appropriate capital investment decision.

(b) In each of the following scenarios, state whether the capital investment decision in (a) above could change. [State “COULD CHANGE” or “WOULD NOT CHANGE”, providing a one-two sentence explanation for each. Treat each scenario as separate].

1. Capital rationing is in place ($1 million annual ceiling).
2. 2. Projects A and B are of unequal lives.
3. 3. Projects A and B are independent projects.
4. 4. Project B costs only $500,000 and its IRR is greater than that of Project A.

 

3)

Why do companies enter into capital budgeting decisions?

 

 

4 )

Create a table showing ALL concepts/tools a firm might use in capital budgeting decisions (INCLUDING THOSE DISCUSSED ABOVE) and outline their strengths and weaknesses

 

Tool/Concept	Strengths	Weaknesses
Add more rows as required

 

Question 2

Analysis of a Project

XYZ Packaging is considering expanding its production capacity by purchasing a new machine, the PX1. The cost of the PX1 is $2.75 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $50,000 feasibility study to analyze the decision to buy the PX1, resulting in the following estimates:

Marketing: Once the PX1 is operating next year, the extra capacity is expected to generate $10.0 million per year in additional sales, which will continue for the ten-year life of the machine.

Operations: The disruption caused by the installation will decrease sales by $5 million this year (year 0). As with XYZ existing products, the cost of goods for the products produced by the PX1 is expected to be 70% of their sale price. The increased production will require additional inventory on hand of $1.0 million, to be added in year 0 and depleted in year 10.

Human Resources: The expansion will require additional sales and administrative personnel at a cost of $2 million per year.

Accounting: The PX1 will be depreciated straight-line in years 1 to 10. Receivables are expected to be 15% of revenues and payables are expected to be 10% of the cost of goods sold. XYZ marginal corporate tax rate is 35%.

 

Questions :

1. Determine the incremental earnings from the purchase of the PX1.
2. Determine the free cash flow from the purchase of the PX1.
3. If the appropriate cost of capital for the expansion is 10%, compute the NPV of the purchase.
4. While the expected new sales will be $10.0 million per year from the expansion, estimates range from a worst case of $8,000,000 to a best case of $12,000,000. What is the NPV in the worst case? In the best case?
5. If the appropriate cost of capital for the expansion is 10%, what is the break-even level of sales for the expansion? What is the break-even level for the cost of goods sold?
6. XYZ could instead purchase the PX200 for even greater capacity. The cost of the PX200 is $4 million. The extra capacity would not be useful in the first two years of operation, but would allow for additional sales in years 3-10. What additional sales (above the $10.0 million expected for the PX1) per year in those years would justify purchasing the larger machine?

 

 

Question 3

Bonds

KLM Enterprises would like to raise $10 million to invest in capital expenditure. The company plans to issue five-year bonds with a face value of $1,000 and a coupon rate of 6.5% (annual payments). The following table summarizes the yield to maturity for five-year (annual-pay) coupon corporate bonds of various ratings

Rating	AAA	AA	A	BBB	BB
Yield to Maturity (%)	6.20	6.30	6.50	6.90	7.50

 

 

1. Assuming the bonds will be rated AA, what will the price of the AA-rated bonds be?
2. How much total principal amount of these bonds must KLM issue to raise $10 million today, assuming the bonds are AA rated? (Because KLM cannot issue a fraction of a bond, assume all fractions are rounded to the nearest whole number.)
3. What must the rating of the bonds be for them to sell at par? (Select the best choice.)
4. Suppose that when the bonds are issued, the price of each bond is $959.54. What is the likely rating of the bonds? Are they junk bonds?
5. In no more than 400 words (point form acceptable) describe the rating process of a rating agency. Why are rating agencies used?
6. In no more than 400 words (point form acceptable) describe a junk bond. How does a bond become a junk bond? Is a junk bond always a junk bond?