Posted: November 13th, 2015
Financial Management
exam
You are evaluating two mutually exclusive projects with the following net cash flows: project x is a three year project and project z is a four yr project
Project X Project Z
YearCash FlowCash Flow
0 -$200,000 -$300,000
1 70,000 50,000
2 100,000 80,000
3 140,000100,000
4 280,000280,000
The cost of capital is 15 percent.
- What is each project X’s payback period? If the cutoff period is 3 years, will you accept project x?
- What is each project’s discounted payback period? If the cutoff period is 3 year, will you accept project z?
- What is each project’s NPV? Which project would you choose based on NPV rule?
- What is each project’s IRR? Which project would you choose based on IRR rule?
- What is each project’s profitability index? Based on profitability index, which project is preferred?
- What is each project’s equivalent annual annuity (EAA)? Based on EAA, which project is preferred?
- Why irr rule and npv rule lead to different decisions? Which rule is more appropriate to evaluate mutually exclusive projects? Why?
- Which project evaluation rule is the most appropriate one to use for selecting these two projects?
You are employed by Merrill lynch, an investment company. You are asked by your manager to value a target firm which one of your client company plans to acquire the following is the balance sheet of the firm on dec 31, 2014.
2013 2014
30 52
100 110
130 162
Liabilities
20 38
80 80
100 118
30 44
130 162
In 2014, the FCF of the firm is $14 million
The tax rate of the firm is 35%
The beta of the firm’s common stock is 1.6. the risk free rate return and the market return is 4% and 12% respectively.
The newly issued long term bonds are 10-yr 8% semiannual coupon bonds. YTM is 10%.
Firm’s FCF is expected to grow at 10% in 2015 and then 5% after forever.
Firm has $25 mil nonoperating assets.
Stock price as of dec 31 2014 is $68/share.
- What is the value of Debt used to compute WACC?
- What is the value of equity used to compute WACC?
- What is the after tax cost of debt?
- What is the cost of equity using CAPM?
- What is the WACC of firm as of dec 31 2014?
- What is your estimated value of operation of the firm as of dec 31 2014?
- What is the estimated corporate value as of dec 31 2014 based on the FCF model?
- What is the estimated stock price as of dec 31 2014 based on the FCF model?
Baldwin Company is considering investing in a machine to produce bowling balls. This project is expected to last for two years. The bowling balls would be manufactured in a building owned by the firm. Detail:
Cost of test marketing, already spent, is $200,000.
Cost of bowling ball machine is $150,000. It will be depreciated to zero using straight line depreciation method for two years. The machine can be sold at $70,000 at the end of the project.
Net operating working capital is estimated to be 15% of the next year’s sales revenue and investments in net operating working capital will be recovered at end of project.
Demand estimates in units for bowling balls for year 1 and 2 are 5000 and 7000 respectively.
Unit price of bowling ball in 1st year is $25 and increases 5% per year after.
Unit production cost of bowling balls in 1st year is 410 and also increases at 5% per year after.
Tax rate 30%.
- Should cost of test marketing be included in the cash flow estimation? Why?
- What is annual depreciation cost for the machine?
- What are operating cash flows for year 1?
- What is cash flow for year 0-2 due to changes in net operating working capital?
- What is the net cash flow for sales of the machine at the end of the project?
exam
You are evaluating two mutually exclusive projects with the following net cash flows: project x is a three year project and project z is a four yr project
Project X Project Z
YearCash FlowCash Flow
0 -$200,000 -$300,000
1 70,000 50,000
2 100,000 80,000
3 140,000100,000
4 280,000280,000
The cost of capital is 15 percent.
- What is each project X’s payback period? If the cutoff period is 3 years, will you accept project x?
- What is each project’s discounted payback period? If the cutoff period is 3 year, will you accept project z?
- What is each project’s NPV? Which project would you choose based on NPV rule?
- What is each project’s IRR? Which project would you choose based on IRR rule?
- What is each project’s profitability index? Based on profitability index, which project is preferred?
- What is each project’s equivalent annual annuity (EAA)? Based on EAA, which project is preferred?
- Why irr rule and npv rule lead to different decisions? Which rule is more appropriate to evaluate mutually exclusive projects? Why?
- Which project evaluation rule is the most appropriate one to use for selecting these two projects?
You are employed by Merrill lynch, an investment company. You are asked by your manager to value a target firm which one of your client company plans to acquire the following is the balance sheet of the firm on dec 31, 2014.
2013 2014
30 52
100 110
130 162
Liabilities
20 38
80 80
100 118
30 44
130 162
In 2014, the FCF of the firm is $14 million
The tax rate of the firm is 35%
The beta of the firm’s common stock is 1.6. the risk free rate return and the market return is 4% and 12% respectively.
The newly issued long term bonds are 10-yr 8% semiannual coupon bonds. YTM is 10%.
Firm’s FCF is expected to grow at 10% in 2015 and then 5% after forever.
Firm has $25 mil nonoperating assets.
Stock price as of dec 31 2014 is $68/share.
- What is the value of Debt used to compute WACC?
- What is the value of equity used to compute WACC?
- What is the after tax cost of debt?
- What is the cost of equity using CAPM?
- What is the WACC of firm as of dec 31 2014?
- What is your estimated value of operation of the firm as of dec 31 2014?
- What is the estimated corporate value as of dec 31 2014 based on the FCF model?
- What is the estimated stock price as of dec 31 2014 based on the FCF model?
Baldwin Company is considering investing in a machine to produce bowling balls. This project is expected to last for two years. The bowling balls would be manufactured in a building owned by the firm. Detail:
Cost of test marketing, already spent, is $200,000.
Cost of bowling ball machine is $150,000. It will be depreciated to zero using straight line depreciation method for two years. The machine can be sold at $70,000 at the end of the project.
Net operating working capital is estimated to be 15% of the next year’s sales revenue and investments in net operating working capital will be recovered at end of project.
Demand estimates in units for bowling balls for year 1 and 2 are 5000 and 7000 respectively.
Unit price of bowling ball in 1st year is $25 and increases 5% per year after.
Unit production cost of bowling balls in 1st year is 410 and also increases at 5% per year after.
Tax rate 30%.
- Should cost of test marketing be included in the cash flow estimation? Why?
- What is annual depreciation cost for the machine?
- What are operating cash flows for year 1?
- What is cash flow for year 0-2 due to changes in net operating working capital?
- What is the net cash flow for sales of the machine at the end of the project?
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