instuctions:Spring 2016 Business Financial Management YangHomework Assignment 3
Due: Wednesday, March 23rd 2016, noon
EMAIL SUBMISSIONS WILL NOT BE ACCEPTED
Instructions: Complete the following problems. The entire assignment is worth 100 points.
Each student must submit an individual assignment which reflects their own work. Part I of the
assignment is composed of 10 problems which are worth 5 points each. No partial credit will be
given for a wrong answer, but you must show your work to receive full credit. Part II of the
assignment is composed of 5 problems worth 10 points each. Partial credit is possible, but full
credit will not be given to a correct answer without showing your work. Showing your work
means either 1) showing the formulas/steps in your calculation, or 2) listing the values you
entered into your financial calculator (e.g., PV=, FV=, etc). Feel free to use your financial
calculators for any of the problems. Do not round your calculator inputs, but you can round
your final answer to two decimal places.
***Important: Place a box or circle around your final answer!***
PART I: (10 problems worth 5 points each – total of 50 points – no partial credit)
1) What is the net present value of a project with the following cash flows if the required rate of
return is 14 percent?
Year 0 1 2 3 4
Cash Flow -$381,342 $123,823 $148,672 $100,523 $130,745
2) What is the profitability index of a project that has an initial cash outflow of $30,600 and the
following cash inflows? The required return is 10.85 percent.
Year 1 2 3 4
Cash Inflow $13,600 $15,200 $0 $14,900
3) What is the internal rate of return on an investment with the following cash flows?
Year 0 1 2 3
Cash Flow -$83,800 $16,340 $88,310 $29,920
4) You are considering a project with an initial cost of $6,400. What is the payback period for
this project if the cash inflows are $900, $1,450, $2,800, $1,200, and $650 over the next five
years, respectively? (Note: Calculate percentage of years if applicable.)
Spring 2016 Business Financial Management Yang
5) A project has an initial cost of $16,500 and produces cash inflows of $5,400, $6,200, and
$8,700 over the next three years, respectively. What is the discounted payback period if the
required rate of return is 15 percent?
6) Tucker’s Manufacturing purchased a lot in Lake City ten years ago at a cost of $810,000.
Today, that lot has a market value of $1.6 million. At the time of the purchase, the company
spent $125,000 to grade the lot and another $8,000 to build a small garage on the lot to house
additional equipment. The company now wants to build a new facility on the site. The building
cost is estimated at $1.2 million. What amount should be used as the initial cash flow for this
project?
7) Olivia’s Boutique is evaluating a project which will increase annual sales by $85,000 and
annual costs by $52,000. The project will initially require $140,000 in fixed assets which will be
depreciated straight-line to a zero book value over the 5-year life of the project. The applicable
tax rate is 34 percent. What is the operating cash flow for this project?
8) Piano, Inc. is considering the purchase of a $181,000 piece of equipment. The equipment is
classified as 5-year MACRS property. The company expects to sell the equipment after three
years at a price of $65,000. The tax rate is 35 percent. What is the expected after-tax cash flow
from the anticipated sale?
MACRS 5-year property:
Year 1 2 3 4 5 6
Rate 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%
9) A project is expected to generate operating cash flows of $84,000 each year for four years.
The initial cost of the fixed assets is $120,000. These assets will be worthless at the end of the
project. The project requires an initial $6,000 in net working capital held throughout the life of
the project and recovered by the end. What is the project’s net present value if the required rate
of return is 15 percent?
10) A project costs $32,000, will be depreciated straight line to zero over its 3 year life, and will
require a net working capital investment of $9,000 up front. The project generates OCF of
$24,000 every year. The fixed assets sold for $6,000 at the end of the project. If the firm has a
tax rate of 35% and a required return of 13%, what is the project NPV?
Spring 2016 Business Financial Management Yang
Part II (5 problems worth 10 points each unless otherwise stated – total of 50 points –
partial credit is possible.)
Use the following information to answer questions #11 – #12.
The Voice Corporation is expected to generate the following taxable income over the next five
years (in thousands).
Year Taxable Income
1 $75
2 $563
3 $3,480
4 $13,922
5 $36,545
After then, after-tax income are expected to remain stable at the year 5 level. Assume the
discount rate is 18%.
11) Based on Table 2.3 of your text,
a) Calculate the tax bill for each year.
b) Calculate the average tax rate for each year.
c) Calculate the marginal tax rate for each year.
12) Assume that the free cash flow for each year is 65% of after tax income.
a) Estimate the value of The Voice Corporation.
b) If The Voice Corporation has 15 million shares outstanding (and no debt), what is the price
per share?
Use the following information to answer questions #13 – #15.
MicroDryer Enterprises is a company that manufactures microwave dryers. Using
microwaves eliminates shrinkage of cotton and wool. The company currently offers a full
sized dryer and is considering development of a new product: a countertop microwave dryer
that could be used in dorm rooms, apartments, or hotels. The sales and costs estimates for
this new venture are provided below:
Spring 2016 Business Financial Management Yang
x Expected annual sales in year 1 are 215,000 units and are expected to increase at a rate of
12% a year through year 4, at which point sales will decrease at a rate of 18% a year
through year 10. Expected sales price is $250 per unit in today’s dollars.
x No sales cannibalization is expected to occur.
x Expected development costs of the product (at time 0) are $80 million, which will be
depreciated over 10 years using straight-line method.
x Annual fixed costs of production are $1 million and variable costs of production are
estimated to be $100 per unit in today’s dollars.
x Sale price, fixed and variable costs of production are expected to increase at the rate of
5.5% annually.
x The tax rate for MicroDryer Enterprises is 34%.
x The inventory balance is 25% of revenues, accounts payable are 50% of inventory, and
accounts receivables are 10% of revenues.
x The expected life of the project is not known, so the company has estimated that cash
flows after the tenth year will increase at an annual rate of 3.5%. (Do not recover the
NWC at the end of ten years.)
x The firm’s discount rate is 19%.
Your task, as a high-flying analyst at MDE, is to value the new product line and advise MDE
on the investment.
13) Assume now is the end of 2014. For the first ten years (from now until 2024), complete a
pro forma statement (forecast of Free Cash Flow) in Excel spreadsheet.
(HINT: The steps required are i) determine the initial costs for the project in 2014, ii) forecast
sales, costs, etc through 2015 – 2024, iii) calculate EBIT for the years 2015 – 2024, iv) use EBIT
to calculate Free Cash Flow.)
14) Calculate the NPV of the new business line. To do this, answer the following:
a) Now estimate the continuing value at the end of year ten. Combine this with the free cash
flows from Q13. Be careful about the timing!
b) Calculate the NPV of the new business line. Should MDE go ahead with the project? Explain
using one sentence.
Note on Excel: Be careful with the “NPV” function in Excel. The NPV function in Excel
uses only future cash flows (cash flows in time 1 and onwards). You must manually adjust
by adding the initial (time 0) cash flow.
c) A colleague points out that MDE spent $30 million exploring the viability of this exact
product line 2 years ago. He argues that you should include the $30 million as a cost in your
valuation. Do you agree? Explain in less than three sentences.
Spring 2016 Business Financial Management Yang
15) Your boss asks you to run a sensitivity analysis. In particular:
a) She is concerned about the continuing value. What happens to the NPV if cash flows only
grow at 1.5% after year 10?
b) She is concerned that the project is riskier than MDE’s current assets. If the true discount rate
is 38% should MDE invest in the new project?
***Important: Place a box or circle around your final answer!***