Finance easy assignment

ASSIGNMENT 4

MGF 301

Corporation Finance

Fall 2016

DUE: Wednesday, November 16th 11:00am in Jacobs 365

(In Singapore time deadline is Wednesday, November 16th at midnight)

You may work in a group of up to 4 on this Assignment. Please indicate clearly on all submitted Assignments who the members of the group are. Please note, all assignments submitted with more than 4 group members will automatically receive a 0 grade.

No late assignments will be accepted. You may hand in the assignment in person in Jacobs 365 (put it under the door if no one is there) or submit it by email to the link in UBLearns before the time it is due. All electronic submissions must be to the link in UBLearns (Note: please follow all the Digital Submission rules (see Syllabus).

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Answer all of the following questions. For each answer, show your work to get full points (stating the answer alone is not sufficient).

1. Suppose Palmer Properties is considering investing $3.6 million today (i.e., C0 = -3,600,000) on a new project that is expected to last for 8 years. The project is expected to generate annual cash flows of C1 = -200,000; C2 = 400,000, C3 = 750,000 and then $900,000 for period C4 through C8. If the discount rate is 7% and management’s payback period cutoff is 5 years:

(a) What is the payback period for the project? Show your work

Invsetment : 3,600,000

Year 1 + Year 2 + Year 3 + Year 4 + Year 5 + Year 6

=-200,000+400,000+750,000+900,000+900,000+900,000

=3,650,000

Payback period: 6 years

(b) What is the net present value of the project ? Show your work

CF PV

0 -3600000 -3600,000

1 -200,000 (-200,000)/(1+0.07)^1= -186,916

2 400,000 400,000/(1+0.07)^2= 349,375

3 750,000 750000/(1+0.07)^3 = 612,223

4-8 900,000 (900,000*(1/0.07-1/(0.07*(1+0.07)^5))/(1+0.07)^4= 2815,219

Net present value = -3,600,000-186916+349375+612223+2815219= -2543799

(c) What is the internal rate of return on the project ? Show your work

CF

0 -3,600,000

1 -200,000

2 400,000

3 750,000

4 900,000

5 900,000

6 900,000

7 900,000

8 900,000 Internal rate of return = USE EXCEL FORMULA

= IRR ( -3,600,000:900,000)

= 8.03%

(d) Under which method(s) above should the company accept the project (applying the acceptance rules)? Explain

Under payback, we accept if the project pays back within the payback period. This project pays back in year 6, so it pays back after the payback cutoff of 5 years and

We reject the project. Under NPV, we accept if the NPV is positive. So we reject under NPV here. Under IRR, we accept if the IRR is greater than the required rate of return. As (IRR%8.03% > 7%), we accept under IRR.

2. The company is choosing between machine A and B (they are mutually exclusive and the company can only pick one). The initial cost of machine A is $500,000 and it will last for 7 years before it needs to be replaced. The cost of operating machine A each year is $50,000. The initial cost of Machine B is $300,000 and it will last for 5 years before it needs to be replaced. The cost of operating machine B is $90,000 in cash flow per year. If the required rate of return is 8%,

(a) Calculate the 7 year and 5 year annuity factors at 8% annual interest.

Annuity Factor A = 1/0.08-1/(0.08*(1+0.08)^7) =5.2064

Annuity Factor B = 1/0.08-1/(0.08*(1+0.08)^5)= 3.9927

(b) Using the annuity factors, find the PV of Machine A and Machine B including all costs (initial + operating).

PVa = -500,000-5.2064*50,000

NPVa = -760320

PVb = -300,000- 3.9927*90,000

NPVb =-659343

(c) Which machine is a better choice for the company after considering the different lives of the projects? (Note: be sure to use the equivalent annual annuity method)

EAAa= npv a/ annual factor a =-760320/5.2064 =-146036

EAAb=npv b/ annual factor b = -659343/3.9927=-165137

Machine A has a lower EAA so it is a better choice.

3. BMT has developed a new product. It can go into production for an initial investment of $2,000,000. The equipment will be depreciated using straight-line depreciation over 5 years to a value of zero. The firm believes that net working capital at each date will equal 30 percent of next year’s forecast sales. The firm estimates that variable costs are equal to 40% of sales and fixed costs are $400,000 per year. Sales forecasts in dollars are below. The project will come to an end after 4 years, when the product becomes obsolete. The firm’s tax rate is 35 percent, and the discount rate is 9 percent. Calculate the NPV.

Year 0 1 2 3 4

Sales forecast (in $): 0 800,000 2,400,000 2,700,000 3,200,000

Year: 0 1 2 3 4

A. Fixed assets

Investment in

Fixed assets 2,000,000

CF, invest.

In fixed assets -2,000,000 0 0 0 0

B. Working capital

Working capital 800,000*0.3 2400,000*0.3 2700,000*0.3 3200,000*0.3 0

240,000 720,000 810000 960000 0

Change in working capital 240000 480000 90000 150000 -960000

CF, invest. In work capital -240000 -480000 -90000 -150000 960000

C. Operations

Revenues 800,000 2400,000 2700,000 3200,000

Variance costs (0.4) 320,000 960,000 1080,000 1280,000

Fixed costs 400,000 400,000 400,000 400,000

Depreciation (4 years) 500,000 500,000 500,000 500,000

Pretax profit -420,000 540,000 720,000 1020,000

Tax (35%) -147000 189000 252000 357000

Profit after tax - 273000 351000 468000 663000

Cash flow from operations 227000 851000 968000 1163000

D. Total project cash flow -2240000 -253000 7618000 818000 2123000

(CF invest. In fixed asset

+CF invest. In working capital

+cash flow from operations)

net present value = -2240000+(-253000/(1+0.09)^1)+761000/(1+0.09)^2+818000/(1+0.09)^3+2123000/(1+0.09)^4 = 304041

4. In problem 3, perform sensitivity analysis on the following assumptions and find the revised NPV

(a) sales are 10% lower each year than predicted above

Year: 0 1 2 3 4

A. Fixed assets

Investment in

Fixed assets 2,000,000

CF, invest.

In fixed assets -2,000,000 0 0 0 0

B. Working capital

Working capital 720000*0.3 2160000*0.3 2430000*0.3 2880000*0.3 0

216000 648000 729000 864000 0

Change in working capital 216000 432000 81000 1350000 -864000

CF, invest. In work capital -216000 -432000 -81000 -135000 864000

C. Operations

Revenues 720000 2160000 2430000 2880000

Variance costs (0.4) 288000 864000 972000 1152000

Fixed costs 400,000 400,000 400,000 400,000

Depreciation (4 years) 500,000 500,000 500,000 500,000

Pretax profit -468,000 396,000 558,000 828,000

Tax (35%) -163800 138600 195300 289800

Profit after tax -304200 257400 362700 538200

Cash flow from operations 195800 757400 862700 1038200

D. Total project cash flow -2216000 -236200 676400 727700 1902200

(CF invest. In fixed asset

+CF invest. In working capital

+cash flow from operations)

net present value = -2216000+(-236200/(1+0.09)^1)+676400/(1+0.09)^2+727700/(1+0.09)^3+1902200/(1+0.09)^4 = -46099

(b) the discount rate is 12 percent

Year: 0 1 2 3 4

A. Fixed assets

Investment in

Fixed assets 2,000,000

CF, invest.

In fixed assets -2,000,000 0 0 0 0

B. Working capital

Working capital 800,000*0.3 2400,000*0.3 2700000*0.3 3200,000*0.3 0

240,000 720,000 810000 960,000 0

Change in working capital 240,000 480,000 90,000 150,000 -960000

CF, invest. In work capital -240,000 -480,000 -90,000 -150,000 -960000

C. Operations

Revenues 800,000 2400,000 2700,000 3200,000

Variance costs (0.4) 320,000 960,000 1080,000 1280,000

Fixed costs 400,000 400,000 400,000 400,000

Depreciation (4 years) 500,000 500,000 500,000 500,000

Pretax profit -420,000 540,000 720,000 1020,000

Tax (35%) -147000 189000 252000 357000

Profit after tax -273000 351000 468000 663000

Cash flow from operations 227000 851000 968000 1163000

D. Total project cash flow -2240000 -253000 761000 727700 1902200

(CF invest. In fixed asset

+CF invest. In working capital

+cash flow from operations)

net present value = -2240000+(-253000/(1+0.12)^1)+761000/(1+0.12)^2+818000/(1+0.12)^3+2123000/(1+0.12)^4 = 72213