Finance work in 3 hours

Intermediate Financial Management

Finance 303

School of Business Administration

University of Miami

Homework 2

Deadline: 14 November, 2017

GOOD LUCK!!!

Name on Blackboard: _________________________

ID Number: __________________________________

Signature: __________________________________

PLEASE NOTE: If any question is unclear to you, make reasonable assumptions, write those

assumptions, and proceed. Also, write in detail any calculations you do to solve the exercises.

Question 1 (25 points)

Green Energy, a company which provides eco-friendly innovative microgrid controller solutions,

is considering the acquisition of a new machine to meet the increased demand of its clients. This

project will have 6 years of economic life and the depreciation will take place under the MACRS

Tax Depreciation Schedules. The corporate tax rate is equal to 40% and the WACC is 10%. The

initial investment includes $100,000 for property plant and equipment, $30,000 installation

expenses and $5,000 shipping expenses. Also, there will be a $20,000 inventory increase and

$2,000 accounts payable increase. The incremental revenue will be $120,000 and the incremental

operating costs will be equal to $60,000 during the 1st,2nd,3rd,4th,5th and 6th year of the project.

Also, the expected salvage price of the machine is $20,000 and the terminal book value is equal to

$0.

a. Calculate the NPV of the project. Would you pursue or not this project? (Show in detail your calculations in the space below)

Question 2 (25 points)

Bausch and Lomb (B&L) has a new contact lens technology that provides UV protection. An

outlay of $200M is required for equipment and $50M for additional net working capital (this

working capital is returned at the end of the project). Management expects the product line to have

a 3-year useful life before a newer technology replaces it. The accounting group indicates that the

equipment should be depreciated according to 3-year MACRS. The expected salvage price of the

equipment in three years is $30M (S3). Annual revenues are expected to be $120M and annual

costs are expected to be $20M. In addition, B&L’s marking department anticipates erosion in its

current lines of contact lenses: annual revenues for its current lines are expected to fall $40M, and

because of lower production, its annual costs for its current lines of contact lenses are expected to

fall by $10M.

B&L’s WACC for eyeware investments is 14% and the firm’s marginal tax rate is 40%.

a. Calculate the depreciation expenses for this project over its useful life by completing the following table. (5 points)

b. What is the book value of the equipment at the end of the project’s useful life (Year 3)? Indicate your answer in the box. (5 points)

Book value Year 3

Year MACRS %

Depreciation

Expense (D)

1

2

3

c. Taking into account erosion, what are the incremental revenues and incremental costs for this project over its useful life? To answer this question, complete the following table.

(5 points)

d. Calculate the NPV for this project by completing the following table and entering the NPV in the indicated box. (10 points)

Year ΔR ΔC

1

2

3

NPV

Year −I −ΔWC TD (ΔR−ΔC)(1-T) S−T(S−B) CFAT

0

1

2

3

Question 3 (25 points) The owner of Green, Inc. is considering abandoning the business. By selling their small factory

now, they can obtain an after-tax amount of $1,500,000. Further, they can sell their equipment for

an after-tax amount of $50,000. The annual revenues minus expenses of this firm are $80,000 per

year (assume they are perpetual). The after-tax EAC of the equipment maintenance (including the

depreciation) is $10,000 per year. The corporate tax rate is 40% and the investment cost of capital

is 10%. Calculate the NPV from abandoning the business. Should the owner abandon the business

and why? (Show all your calculations in detail)

Question 4 (25 points) Cisco has identified a market for a new digital phone product. Initial investment in development

is expected to be $70M. The project should have a useful life cycle of 5 years before newer

technology replaces it. The price per phone is expected to be $100 real 2014 dollars. The variable

cost per phone is expected to be $60 real 2014 dollars. (There are no fixed costs except the initial

investment.) Demand for the phone is expected to be 1M (million) units (phones) per year

(remaining the same in each of the 5 years of the project). The initial investment would be

depreciated according to 5-year straight-line depreciation to a $0 terminal book value. At the end

of the project, the equipment could be sold for $10M (S5) real 2014 dollars.

Inflation is expected to be 2% per year for all goods and services. Cisco’s nominal WACC for this

project is 10%, and Cisco’s tax rate is 40%.

a. Calculate nominal revenues (R) and costs (C) for the proposed project by completing the following table. Express prices and costs in dollars per unit to 4 decimal places (for

example, $100.1234 per unit). Express revenues and costs in $M ($ million) to 4 decimal

places (for example, 100.1234 M). (12.5 points)

Year

Nominal Price

per Unit

Nominal Cost

per Unit

Nominal

Revenues (R)

Nominal

Costs (C) Nominal R − C

1 (2015)

2 (2016)

3 (2017)

4 (2018)

5 (2019)

b. Calculate the NPV for this project using a nominal analysis by completing the following table and entering the NPV in the indicated box. Express values in $M ($ millions) to 4

decimal places (for example, 100.1234 M). (12.5 points)

Year −I TD (R−C)(1-T) S−T(S−B) CFAT

0 (2014)

1 (2015)

2 (2016)

3 (2017)

4 (2018)

5 (2019)

NPV