Finance (Math Problem Sample)
1. Neal, Inc. has a capital structure that consists of Bond Issue A @ a rate of 11% $22,000,000 Bond Issue B @ a rate of 13% 10,000,000 Preferred Stock 6,000,000 Common Stock (100,000 shares outstanding) 4,000,000 Retained Earnings 15,000,000 The preferred stock pays a dividend of $7.85 and $52 was received from the initial sale. The common stock paid a $2.50 dividend last year and sells for $28.90 in the market. The company has an expected annual growth rate of 6%. The appropriate cost of capital to be used for capital budgeting projects is ___________. 2. The Mallory Company is evaluating the proposed acquisition of a new milling machine. The machine’s base price is $108,000, and it would cost another $12,500 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating cost, mainly labor. Mallory’s marginal tax rate is 35%. a. What is the net cost of the machine for capital budgeting purposes? (Year 0 net cash flow? b. What are the net operating cash flows in Year 1, 2, and 3? c. What is the additional Year 3 cash flow (after-tax salvage and the return on working capital? d. If the project’s cost of capital is 12%, should the machine be purchased? 3. Jodie Co. is deciding whether to drill for oil on a tract of land that the company owns. The company estimates that the project would cost $8 million today. Jodie estimates that once drilled, the oil will generate positive net cash flows of $4 million a year at the end of each of the next 4 years. While the company is fairly is fairly confident about its cash flow forecast, it recognizes that if it waits 2 years, it would have more information about the local geology as well as the price of oil. Jodie estimates that if it waits 2 years, the project would cost $9 million. Moreover, if it waits 2 years, there is a 90% chance that the net cash flows would be $4.2 million a year for 4 years, and there is a 10% chance that the cash flows will be $2.2 million a year for 4 years. Assume that all cash flows are discounted at 10%. a. If the company chooses to drill today, what is the project’s net present value? b. Using decision tree analysis, does it make sense to wait 2 years before deciding whether to drill? 4. Thompson, Inc. is considering a new production line for its rapidly expanding camping equipment division. The new line will cost $480,000, and will be depreciated on a straight line basis ($160,000/yr.) over the next 3 years leaving no residual value. Other important factors are 1) new sales for each of the next 3 years will be $475,000, $550,000 and $600,000, 2) cost of goods sold, exclusive of depreciation, is 40% of sales, 3) increased G&A and Selling expenses are estimated to be $40,000 per year, and 4) the company\'s cost of capital is 18% with a tax rate of 40%. a. What are the project\'s annual cash flows? b. What is the project\'s NPV? c. What is the approximate IRR? 5. Ruzicki is analyzing the acquisition of another truck which would require an initial investment of $95,000. It expects cash flows of $35,000/year over the next four years. a. On a cost of capital of 14% is the investment worth making? b. Would your decision change if the cash flows were adjusted for less than 100% certainty after the first year with an adjustment factor of 96% for year two and factors of .92, and .85for the remaining two years? There is no doubt that the concept of Real Options is complex and complicated to implement. The use of real options in business is fairly recent so many companies lack the knowledge and ability to use. Discuss any of the following topics. 1. Do you think it is realistic that there will come a time when most corporations will use real options? Why do you think corporations would be hesitant to use real options? 2. What do you think the benefits are of introducing such a tool to an organization? 3. What risks are involved in using real options? 4. What is your opinion of real options in evaluating projects? Is this something you would like to be involved with in your quest to have a terrific finance position? 5. How does this tool differ than just using a technique such as NPV?source..
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