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essentials of management
Essentials Of Financial Management 4th Edition Eugene F. Brigham, Joel F. Houston, Jun-Ming Hsu, Yoon Kee Koong, A. N. Bany-Ariffin - Solutions
15-5 Which of the following would likely encourage a firm to increase the debt in its capital structure?a. The corporate tax rate increases.b. The personal tax rate increases.c. Due to market changes, the firm's assets become less liquid.d. Changes in the bankruptcy code make bankruptcy less costly
15-4 If Congress increased the personal tax rate on interest, dividends, and capital gains but simultaneously reduced the rate on corporate income, what effect would this have on the average company's capital structure?
15-3 Discuss the following statement: All else being equal, firms with relatively stable sales are able to carry relatively high debt ratios. Is the statement true or false? Why?
15-2 Would each of the following increase, decrease, or have an indeterminant effect on a firm's break-even point (unit sales)?a. The sales price increases with no change in unit costs.b. An increase in fixed costs is accompanied by a decrease in variable costs.c. A new firm decides to use MACRS
15-1 Changes in sales cause changes in profits. Would the profit change asso-ciated with sales changes be larger or smaller if a firm increased its oper-ating leverage? Explain your answer.
Explain this statement: Using financial leverage has both good and bad effects.
What is financial risk, and how does it arise?
How does operating leverage affect business risk?
What is operating leverage?
Why does business risk vary from industry to industry?
What are some determinants of business risk?
What is business risk, and how can it be measured?
14-9 a cost of $10 million and an expected life of 3 years. There is a 30% proba-bility of good conditions, in which case the project will provide a cash flow of $9 million at the end of each year for 3 years. There is a 40% probability of average conditions, in which case the annual cash flows
14-8 REAL OPTIONS Use a spreadsheet model to evaluate the project analyzed in problem 14-7.REAL OPTIONS Bankers' Services Inc. (BSI) is considering a project that has
14-7 REAL OPTIONS Nevada Enterprises is considering buying a vacant lot that sells for $1.2 million. If the property is purchased, the company's plan is to spend another $5 million today (t = 0) to build a hotel on the prop-erty. The cash flows from the hotel will depend critically on whether the
14-6 INVESTMENT TIMING OPTION The Bush Oil Company is deciding whether to drill for oil on a tract of land that the company owns. The company esti-mates that the project will cost $8 million today. Bush estimates that once drilled, the oil will generate positive cash flows of $4 million a year at
14-5 its WACC is 12.5%. The company is considering the following seven investment projects:a.Assume that each of these projects is independent and that each is just as risky as the firm's existing assets. Which set of projects should be accepted, and what is the firm's optimal capital budget?b. Now
14-4 ABANDONMENT OPTION The Scampini Supplies Company recently purchased a new delivery truck. The new truck costs $22,500, and it is expected to generate after-tax cash flows, including depreciation, of$6,250 per year. The truck has a 5-year expected life. The expected year-end abandonment values
14-3 INVESTMENT TIMING OPTION Digital Inc. is considering the production of a new cell phone. The project will require an investment of $15 million.If the phone is well received, the project will produce cash flows of$10 million a year for 3 years; but if the market does not like the product, the
14-2 OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings
14-1 GROWTH OPTION Martin Development Co. is deciding whether to proceed with Project X. The cost would be $9 million in Year 0. There is a 50% chance that X would be hugely successful and would generate annual after-tax cash flows of $6 million per year during Years 1, 2, and 3. However, there is
14-5 What is a post-audit; why do firms use them; and what problems can arise when they are used?
14-4 How might a firm's corporate WACC be affected by the size of its capital budget?
14-2 Companies often have to increase their initial investment costs to obtain real options. Why might this be so, and how could a firm decide whether it was worth the cost to obtain a given real option?
14-2 Would a failure to recognize growth options tend to cause a firm's actual capital budget to be above or below the optimal level? Would your answer be the same for abandonment, timing, and flexibility options? Explain.
14-1 Explain in general terms what each of the following real options is and how it could change projects' NPVs and their corresponding risk relative to what would have been estimated if the options had not been considered.a. Abandonmentb. Timingc. Growthd. Flexibility
In terms of Figure 14.5, how would an event such as the credit crisis of 2008, where interest rates for many corporate borrowers climbed quite high, affect the size of the capital budget?
What is capital rationing? What types of firms might encounter capital rationing?
Explain how a financial manager might estimate his or her firm's optimal capital budget.
Why is a firm's value maximized if it invests to the point where its marginal return on new investment is equal to its marginal cost of capital?
How do flexibility options affect projects' NPVs and risk?
What are input flexibility options and output flexibility options?
Explain why the following statement is true: In general, the more uncertainty there is about future market conditions, the more attractive an investment timing option will be, other things held constant.
Briefly describe what an investment timing option is and why such options are valuable.
13-21 REPLACEMENT ANALYSIS The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more effi-cient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from
13-20 machine 5 years ago at a cost of $90,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $9,000 per year. If the machine is not replaced, it can be sold for $10,000 at the end of its useful life.A new machine
13-19 NEW PROJECT ANALYSIS Holmes Manufacturing is considering a new machine that costs $250,000 and would reduce pretax manufacturing costs by $90,000 annually. Holmes would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a value of $23,000 at
13-18 SCENARIO ANALYSIS Your firm, Agrico Products, is considering a tractor that would have a cost of $36,000, would increase pretax operating cash flows before taking account of depreciation by $12,000 per year, and would be depreciated on a straight-line basis to zero over 5 years at the rate of
13-17 EQUIVALENT ANNUAL ANNUITY A firm has two mutually exclusive investment projects to evaluate; both can be repeated indefinitely. The projects have the following cash flows:Projects X and Y are equally risky and may be repeated indefinitely. If the firm's WACC is 12%, what is the EAA of the
13-16 REPLACEMENT CHAIN The Fernandez Company has an opportunity to invest in one of two mutually exclusive machines that will produce a product the company will need for the next eight years. Machine A costs$10 million but will provide after-tax inflows of $4 million per year for 4 years. If
13-15 REPLACEMENT CHAIN Zappe Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce after-tax cash flows of $30 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce after-tax cash flows
13-14 UNEQUAL LIVES Cotner Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new models are available:(a) Machine 190-3, which has a cost of 5190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year;
13-13 UNEQUAL LIVES Haley's Graphic Designs Inc. is considering two mutu-ally exclusive projects. Both projects require an initial investment of$10,000 and are typical average-risk projects for the firm. Project A has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at
13-12 PROJECT RISK ANALYSIS The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,750 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability distributions:BPC
13-11 REPLACEMENT ANALYSIS Mississippi River Shipyards is considering the replacement of an 8- year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year. The new machine will cost $82,500, and it will have an estimated life of 8 years
13-10 REPLACEMENT ANALYSIS The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this
13-9 NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The applicable depreci-ation
13-8 NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3
13-7 SCENARIO ANALYSIS Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be "average." However, the CFO realizes that condi-tions could be better or worse, so she performed a scenario analysis and obtained
13-6 DEPRECIATION METHODS Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line
13-5 EQUIVALENT ANNUAL ANNUITY Corcoran Consulting is deciding which of two computer systems to purchase. It can purchase state-of-the-art equipment (System A) for $20,000, which will generate cash flows of$6,000 at the end of each of the next 6 years. Alternatively, the company can spend $12,000
13-4 REPLACEMENT ANALYSIS The Chang Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The
13-3 AFTER-TAX SALVAGE VALUE Kennedy Air Services is now in the final year of a project. The equipment originally cost $20 million, of which 80%has been depreciated. Kennedy can sell the used equipment today for $5 million, and its tax rate is 40%. What is the equipment's after-tax salvage value?
13-2 PROJECT CASH FLOW Eisenhower Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:Sales revenues$10 million Operating costs (excluding depreciation)7 million Depreciation 2
13-1 REQUIRED INVESTMENT Truman Industries is considering an expansion. The necessary equipment would be purchased for $9 million, and the expansion would require an additional $3 million investment in net oper- ating working capital. The tax rate is 40%.a. What is the initial investment outlay?b.
13-13 Suppose a firm is considering two mutually exclusive projects. One project has a life of 6 years; the other, a life of 10 years. Both projects can be repeated at the end of their lives. Might the failure to employ a replace-ment chain or EAA analysis bias the decision toward one of the
13-12 What is an "equivalent annual annuity (EAA)"? When and how are EAAs used in capital budgeting?
13-11 What is a "replacement chain"? When and how should replacement chains be used in capital budgeting?
13-10 If you were the CFO of a company that had to decide on hundreds of potential projects every year, would you want to use sensitivity analysis and scenario analysis as described in the chapter, or would the amount of arithmetic required take too much time and thus not be cost-effective?What
13-9 Define (a) sensitivity analysis, (b) scenario analysis, and (c) simulation analysis. If GE were considering two projects (one for $500 million to develop a satellite communications system and the other for $30,000 for a new truck), on which would the company be more likely to use a simula-tion
13-8 In theory, market risk should be the only "relevant" risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?
13-7 Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in the capital budget.
13-6 What are some differences in the analysis for a replacement project versus that for a new expansion project?
13-5 Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased? If so, would the NPV be biased up or
13-4 Why are interest charges not deducted when a project's cash flows for use in a capital budgeting analysis are calculated?
13-3 Explain why net operating working capital is included in a capital budg-eting analysis and how it is recovered at the end of a project's life.
13-2 Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs and externalities should be included. Give an example of each.
13-1 Operating cash flows rather than accounting income are listed in Table 13.1. Why do we focus on cash flows as opposed to net income in capital budgeting?
What is Monte Carlo simulation? How does a simulation analysis differ from a regular scenario analysis?
What is a scenario analysis; what is it designed to show; and how does it differ from a sensitivity analysis?
Explain briefly how a sensitivity analysis is done and what the analysis is designed to show.
What is one classification scheme that firms often use to obtain risk-adjusted costs of capital?
Which type is theoretically the most relevant? Why?
What are the three types of project risk?
Why does net operating working capital (NOWC) appear as both a negative and a positive number in Table 13.1?
How could the analysis in Table 13.1 be modified to consider cannibalization, opportunity costs, and sunk costs?
Would a project's NPV for a typical firm be higher or lower if the firm used accelerated rather than straight-line depreciation? Explain.
In what ways is the setup for finding a project's cash flows similar to the projected income statements for a new single-product firm? In what ways would the two statements be different?
12.21 MIRR Project X costs $1,000, and its cash flows are the same in Years 1 through 10. Its IRR is 12%, and its WACC is 10%. What is the project's MIRR?12.22 MIRR A project has the following cash flows:0 23 45-$500$202-$X$196$350$451 This project requires two outflows at Years 0 and 2, but the
12.20 NPV A project has annual cash flows of $7,500 for the next 10 years and then $10,000 each year for the following 10 years. The IRR of this 20-year project is 10.98%, If the firm's WACC is 9%, what is the project's NPV?
12.19 MULTIPLE IRRS AND MIRR A mining company is deciding whether to open a strip mine, which costs $2 million. Cash inflows of $13 million would occur at the end of Year 1.The land must be returned to its natural state at a cost of $12 million, payable at the end of Year 2.a. Plot the project's
12.17 CAPITAL BUDGETING CRITERIA A company has a 12% WACC and is considering two mutually exclusive investments (that cannot be repeated)with the following cash flows:2 35 67 Project A -$300-$387 -$193-$100$600$600$850 -$180 Project B - $405$134$134$134 5134$134$134$0 a.What is each project's
12.16 NPV PROFILES: SCALE DIFFERENCES A company is considering two mutually exclusive expansion plans. Plan A requires a $40 million expend-iture on a large-scale integrated plant that would provide expected cash flows of $6.4 million per year for 20 years. Plan B requires a $12 million expenditure
12.15 NPV PROFILES: TIMING DIFFERENCES An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $14.4 million. Under Plan B, cash flows would be $2.1
12.14 CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low
12.13 MIRR A firm is considering two mutually exclusive projects, X and Y, with the following cash flows;1 23 Project X -$1,000$100$300$400$700 Project Y-$1,000$1,000$100 S50$50 The projects are equally risky, and their WACC is 12%. What is the MIRR of the project that maximizes shareholder value?
12.12 IRR AND NPV A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:0 12 3Project S-$1,000$900$250$10$10 Project L-$1,000$0$250$400$800 The company's WACC is 10%. What is the IRR of the better project? (Hint:The better project may or may not be the one
12.11 CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS Project S costs $15,000, and its expected cash flows would be $4,500 per year for 5 years, Mutually exclusive Project L costs $37,500, and its expected cash flows would be $11,100 per year for 5 years. If both projects have a WACC of
12.10 CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a WACC of 10% is considering the following mutually exclusive projects: 0 2 3 4. 5 H Project A-$400 $55 $55 $55 $225 $225 Project B -$600 $300 $300 $50 $50 $49 Which project would you recommend? Explain.
12.9 CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS An electric utility is considering a new power plant in northern Arizona. Power from the plant would be sold in the Phoenix area, where it is badly needed.Because the firm has received a permit, the plant would be legal; but it would cause
12.8 CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an additional $10 million at Year 0 to mitigate the
12.7 CAPITAL BUDGETING CRITERIA A firm with a 14% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:a. Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.b. Assuming the projects are independent,
12.6 NPV Your division is considering two projects with the following cash flows (in millions):0 12 3Project A-$25$5$10$17 Proiect B-$20$10 59 56 What are the projects' NPVs assuming the WACC is 5%? 10%? 15%?What are the projects' IRRs at each of these WACCs?c.If the WACC was 5% and A and B were
12.5 DISCOUNTED PAYBACK Refer to problem 12-1. What is the project's discounted payback?
12.4 PAYBACK PERIOD Refer to problem 12-1. What is the project's payback?
12.3 MIRR Refer to problem 12-1. What is the project's MIRR?
12.2 IRR Refer to problem 12-1. What is the project's IRR?
12.1 NPV Project K costs $52,125, its expected cash inflows are $12,000 per year for 8 years, and its WACC is 12%. What is the project's NPV?
12.10 A firm has a $100 million capital budget. It is considering two projects, each costing $100 million. Project A has an IRR of 20% and an NPV of $9million;it will be terminated after 1 year at a profit of $20 million, resulting in an immediate increase in EPS. Project B, which cannot be
12.9 What reinvestment rate assumptions are built into the NPV, IRR, and MIRR methods? Give an explanation for your answer.
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