FINANCIAL MANAGEMENT 2

Homework 2

Show steps for each question. You can use either pricing formula or excel. If you use excel, write down necessary inputs and output.

1. The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $238,000 and cash expenses by $184,000. The initial investment will require $96,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield?

2. Phone Home, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with annual costs of $883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project?

3. You are considering investing in a startup company called Minions Technologies. After careful analysis, you determine that Minions will be able to generate $100,000 in cash flow at the end of each year for the first 5 years. Then, Minions will generate cash flow of $400,000 at the end of the 6th year, after which it will grow at 11% per year forever. Using a discount rate of 18%, what is the amount you would be willing to invest?

4. A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the NPV if the firm's marginal tax rate is 35% and discount rate is 10%?

5. Motor City Productions sells original automotive art on a prepaid basis as each piece is uniquely designed to the customer's specifications. For one project, the cash flows are estimated as follows. Based on the internal rate of return (IRR), should this project be accepted if the required return is 9 percent?

(Hint: You may or may not be able to use the simple default IRR rule)

(a) IRR is 7.27%. Accept the project.

(b) IRR is 7.27%. Reject the project.

(c) IRR is 9%. Accept the project.

(d) IRR is 9%. Reject the project.

6. OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship would cost $500 million but would operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $70 million and its cost of capital is 12%. Using a financial calculator, identify the IRR of the new ship. Should OpenSeas go ahead with the purchase? How far off could OpenSeas’ cost of capital estimate be before your purchase decision would change?

(a) IRR=12.72%, Yes, 0.72%

(b) IRR=11.25%, No, 0.75%

(c) IRR=14.82%, Yes, 2.82%

(d) IRR=9.34%, Yes, 2.66%

7. Fabulous Fabricators needs to decide how to allocate space in its production facility this year. It is considering the following contracts:

(a) Invest in A

(b) Invest in C

(c) Invest in C and B

(d) Invest in B

8. A project’s cash flows are listed below. Assume the appropriate discount rate for this project is 14%. The profitability index for this project is closest to ________.

Year	Cash Flow
0	-8000
1	3200
2	3200
3	3200
4	3200

(a) 0.17

(b) 0.25

(c) 0.66

(d) 0.18

9. A firm faces three investment opportunities A, B and C:

A. NPV = $3m, investment = $1m

B. NPV = $2m, investment = $2m

C. NPV = $2.5m, investment = $3m

Given a total of $4m initial resources, which one(s) should the firm take? Explain.

NPVUse of Facility

A$2 million100%

B$1 million60%

C$1.5 million40%