4. You go to your desk and your boss comes in. I need you to do...

   

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4. You go to your desk and your boss comes in. "I need you to do some work for me. Read this and tell me what you think." The assignment indicates that following" StuartCo Trains is a large Tank maker. It recently built the T123. It can carry a huge payload and is more nimble than other tanks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2010. Assume that StuartCo will produce 60 Tanks per year for five years. Each Tank will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs) occurring on Dec 31, 2011. The assignment your boss gives you asks you to determine the NPV of the project if StuartCo's cost of capital is 11%? Calculate the NPV as of Dec 31, 2010. Ignore taxes and assume that there are no terminal year cash flows. Show your work, as appropriate and clearly state your answer (5 points) 5. Your boss then asks what is the payback period for the StuartCo investment outlined above? Amd, the CEO doesn't really get payback - so how should I explain it to him. What does the payback period calculation mean? (5 marks) 6. Your boss than asks you to calculate the Profitability Index as of Dec 31, 2010 for the StuartCo investment outlined in #4 above. (4 marks) 7. Your boss wants a recommendation - but based on only one of the three sets of analysis above (either NPV, Payback or Profitability Index). Which method do you choose? Why? (3 marks) 8. Your boss now asks you to tackle something new. StuartCo is now planning to make a special add- on investment to its tanks. The changes will cost $3 million in total, with the expenditure occurring at the end of the year three years from today. The changes will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years. It will then cost $.5 million to dispose of specialized waste generated by the project at the end of the 3rd year of operation. Your boss asks you the following: (a) What is the project's IRR? (2 marks) (b) If Stuart Co Industries requires a minimum return of 10%, should this project be accepted? Why? What if the minimum return was 15%? (3 marks) 9. Stuart Co is now considering two independent projects utilizing the internal rate of return technique. Project A has an initial investment of $120,000 and cash inflows at the end of each of the next four ALGONQUIN COLLEGE Online years of $40,000. Project B has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. (3 marks) (a) Which projects should be accepted if the cost of capital is 15%? (b) Which projects should be accepted if the cost of capital is 10% 10. Your boss attended a conference and heard about the modified IRR. He decides that this is what the company should use to analyze projects. The project he wants analyzed has a cost of $1,000 at Time = 0 and inflows of $300 at the end of Years 1-5. The new cost of capital is 10%. He asks you to calculate the project's modified IRR (MIRR) (5 marks) Part C: Calculating WACC and the Cost of Preferred Stock (15 points) 11. Your boss asks you to look at East Africa Airways. It has debt with a book value of $20M, currently trading at 85% of book value. It also has book value of equity of $30M, and 2M shared of common stock tracing at $4.75 per share. What weights should be used for debt ad equity in calculating its WACC? (3 points) 12. Your boss is keen for you to learn more about Airlines. South American Airlines' (SAA) shares are currently trading at $69.25 each. The yield on the company's debt is 4% and the firm's beta is 0.7. The T-Bill rate is 4% and the expected return on the market (E (KM)) is 9%. The company's target capital structure is 25% debt and 75% equity. The company pays a combined income tax rate of 35%. The GST rate is 13%. What is SAA's cost of equity? (3 marks) 4. You go to your desk and your boss comes in. "I need you to do some work for me. Read this and tell me what you think." The assignment indicates that following" StuartCo Trains is a large Tank maker. It recently built the T123. It can carry a huge payload and is more nimble than other tanks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2010. Assume that StuartCo will produce 60 Tanks per year for five years. Each Tank will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs) occurring on Dec 31, 2011. The assignment your boss gives you asks you to determine the NPV of the project if StuartCo's cost of capital is 11%? Calculate the NPV as of Dec 31, 2010. Ignore taxes and assume that there are no terminal year cash flows. Show your work, as appropriate and clearly state your answer (5 points) 5. Your boss then asks what is the payback period for the StuartCo investment outlined above? Amd, the CEO doesn't really get payback - so how should I explain it to him. What does the payback period calculation mean? (5 marks) 6. Your boss than asks you to calculate the Profitability Index as of Dec 31, 2010 for the StuartCo investment outlined in #4 above. (4 marks) 7. Your boss wants a recommendation - but based on only one of the three sets of analysis above (either NPV, Payback or Profitability Index). Which method do you choose? Why? (3 marks) 8. Your boss now asks you to tackle something new. StuartCo is now planning to make a special add- on investment to its tanks. The changes will cost $3 million in total, with the expenditure occurring at the end of the year three years from today. The changes will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years. It will then cost $.5 million to dispose of specialized waste generated by the project at the end of the 3rd year of operation. Your boss asks you the following: (a) What is the project's IRR? (2 marks) (b) If Stuart Co Industries requires a minimum return of 10%, should this project be accepted? Why? What if the minimum return was 15%? (3 marks) 9. Stuart Co is now considering two independent projects utilizing the internal rate of return technique. Project A has an initial investment of $120,000 and cash inflows at the end of each of the next four ALGONQUIN COLLEGE Online years of $40,000. Project B has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. (3 marks) (a) Which projects should be accepted if the cost of capital is 15%? (b) Which projects should be accepted if the cost of capital is 10% 10. Your boss attended a conference and heard about the modified IRR. He decides that this is what the company should use to analyze projects. The project he wants analyzed has a cost of $1,000 at Time = 0 and inflows of $300 at the end of Years 1-5. The new cost of capital is 10%. He asks you to calculate the project's modified IRR (MIRR) (5 marks) Part C: Calculating WACC and the Cost of Preferred Stock (15 points) 11. Your boss asks you to look at East Africa Airways. It has debt with a book value of $20M, currently trading at 85% of book value. It also has book value of equity of $30M, and 2M shared of common stock tracing at $4.75 per share. What weights should be used for debt ad equity in calculating its WACC? (3 points) 12. Your boss is keen for you to learn more about Airlines. South American Airlines' (SAA) shares are currently trading at $69.25 each. The yield on the company's debt is 4% and the firm's beta is 0.7. The T-Bill rate is 4% and the expected return on the market (E (KM)) is 9%. The company's target capital structure is 25% debt and 75% equity. The company pays a combined income tax rate of 35%. The GST rate is 13%. What is SAA's cost of equity? (3 marks)

Answer rating: 100% (QA)

Solution 4 To calculate the NPV of the Stuart Co tank project as of Dec 31 2010 with a cost of capital of 1 Initial investment 138M Cash flows Year 1 ... View the full answer