Question 1

Start with the partial model in the attached.

The stock of Matrix Computing sells for $65, and last year's dividend was $2.53. Security analysts are projecting that the common dividend will grow at a rate of 9% a year. A flotation cost of 12% would be required to issue new common stock. Matrix's preferred stock sells for $42.00, pays a dividend of $3.32 per share, and new preferred stock could be sold with a flotation cost of 10%. The firm has outstanding bonds with 25 years to maturity, a 15% annual coupon rate, semiannual payments, $1,000 par value. The bonds are trading at $1,271.59. The tax rate is 20%. The market risk premium is 5.5%, the risk-free rate is 7.0%, and Matrix's beta is 1.2. In its cost-of-capital calculations, Matrix uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity.

a. Calculate the cost of each capital componentin other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity.

b. Calculate the cost of new stock using the dividend growth approach.

c. Assuming that Matrix will not issue new equity and will continue to use the same tar-get capital structure, what is the company's WACC

Question 2

Start with the partial model in the attached.

Pinto.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $25 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 12% of the year's projected sales; for example, NWC₀= 12%(Sales₁). The servers would sell for $21,000 per unit, and Pinto believes that variable costs would amount to $15,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2.5%. The company's nonvariable costs would be $1.5 million at Year 1 and would increase with inflation. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 2,000 units per year. The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment at the end of the project's 4-year life is $1 million. Pinto.com's federal-plus-state tax rate is 20%. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with an 8% project cost of capital and high-risk projects at 13%.

1. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback.
2. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their base-case values.
3. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions.
4. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback.
5. On the basis of information in the problem, would you recommend the project should be accepted?

Question 3

You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B.Each project has a cost of $50,000, and the cost of capital for each is 10%.

The projects' expected net cash flows are as follows:

Expected Net Cash Flows

Year

Project A

Project B

0

($50,000)

($50,000)

1

25,000

15,000

2

20,000

15,000

3

10,000

15,000

4

5,000

15,000

5

5,000

15,000

1. Calculate each project's payback period, net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).
2. Which project will you select if your decision was based solely on the project's payback period?
3. Which project or projects should be accepted if they are independent?
4. Which project should be accepted if they are mutually exclusive?
5. d. How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two projects? Would this conflict exist if r were 6%? (Hint: Plot the NPV profiles.)

Question 4

Marvin Industries must choose between an electric-powered and a coal-powered forklift machine for its factory. Because both machines perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered machine will cost more, but it will be less expensive to operate; it will cost $102,000, whereas the coal-powered machine will cost $69,500. The cost of capital that applies to both investments is 10%. The life for both types of machines is estimated to be 6 years, during which time the net cash flows for the electric-powered machine will be $26,150 per year, and those for the coal-powered machine will be $20,000 per year. Annual net cash flows include depreciation expenses.

1. Calculate the NPV and IRR for each type of machine, and decide which to recommend

Q1 data:

INPUTS USED IN THE MODEL P₀ $65.00 D₀ $2.53 g 9% Flotation cost for common 12% P_pf $42.00 D_pf $3.32 Flotation cost for preferred 10% Bond maturity 25 Payments per year 2 Annual coupon rate 15% Par $1,000.00 Bond price $1,271.59 Tax rate 20% Beta 1.2 Market risk premium, RP_M 5.5% Risk free rate, r_RF 7.0% Target capital structure from debt 40% Target capital structure from preferred stock 10% Target capital structure from common stock 50% a.Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs).Use both the the CAPM method and the dividend growth approach to find the cost of equity. Cost of debt: N = 50 PMT = $75.00 PV = -$1,271.59 FV = $1,000.00 Semiannual yield = RATE = AnnualB-T r_d= B-T r_d (1 - T) = A-T r_d 0% = Cost of preferred stock (including flotation costs): D_pf/ NetP_pf = r_pf = Cost of common equity, dividend growth approach (ignoring flotation costs): D₁/ P₀+ g= r_s Cost of common equity, CAPM: r_RF+ bRP_M = r_s = b.Calculate the cost of new stock using the dividend growth approach (include flotation costs). D₀ (1 + g)/ P₀ (1 - F)+ g= r_e c.Assuming that Gao will not issue new equity and will continue to usethe same capital structure, what is the company's WACC? w_d 40.0% w_pf 10.0% w_s 50.0% 100.0% w_d A-T r_d+ w_pf r_pf+ w_s r_s = WACC =

Q2 data:

Chapter: 11 Cash Flow Estimation and Risk Analysis a.Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. Input Data (in thousands of dollars) Scenario name Base Case Note: the items in red will be used in a scenario analysis. Probability of scenario 50% Equipmentcost $25,000 Net operating working capital/Sales 12% Key Results: First year sales (in units) 2,000 NPV= Sales price per unit $21.00 IRR= Variable cost per unit (excl. depr.) $15.00 Payback = Nonvariable costs (excl. depr.) $1,500 Inflation in prices and costs 2.5% Estimated salvage value at year 4 $1,000 Depreciation years Year 1 Year 2 Year 3 Year 4 Depreciation rates 20.00% 32.00% 19.20% 11.52% Tax rate 20% WACC for average-risk projects 10% Intermediate Calculations 0 1 2 3 4 Units sold Sales price per unit (excl. depr.) Variable costs per unit (excl. depr.) Nonvariable costs (excl. depr.) Sales revenue Required level of net operating working capital Basis for depreciation Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% Annual depreciation expense Ending Bk Val: Cost - Accum Dep'rn Salvage value Profit (or loss) on salvage Tax on profit (or loss) Net cash flow due to salvage Years Cash Flow Forecast 0 1 2 3 4 Sales revenue Variable costs Nonvariable operating costs Depreciation (equipment) Oper. income before taxes (EBIT) Taxes on operating income (20%) Net operating profit after taxes Add back depreciation Equipment purchases Cash flow due to change in NOWC Net cash flow due to salvage Net Cash Flow (Time line of cash flows) Key Results:Appraisal of the Proposed Project Net Present Value (at 10%) = IRR = MIRR = Payback = Discounted Payback = Data for PaybackYears Years 0 1 2 3 4 Net cash flow Cumulative CF Part of year requiredfor payback Data for Discounted PaybackYears Years 0 1 2 3 4 Net cash flow $0 $0 $0 $0 $0 Discounted cash flow Cumulative CF Part of year required for discounted payback b.Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold.Set these variables' values at 10% and 20% above and below their base-case values. % Deviation 1st YEAR UNIT SALES Note about data tables.The data in the column input should NOT be input using a cell reference to the column input cell.For example, the base case 1st Year Unit Sales in Cell B79 should be the number 2,000 and NOT have the formula =D10 in that cell.This is because you'll use D10 as the column input cell in the data table and if Excel tries to iteratively replace Cell D10 with the formula =D10 rather than a series of numbers, Excel will calculate the wrong answer.Unfortunately, Excel won't tell you that there is a problem, so you'll just get the wrong values for the data table! from Base NPV Base Case 2,000 $0 -20% -10% 0% 10% 20% % Deviation SALES PRICE % Deviation VARIABLE COST from Base NPV from Base NPV Base Case $21.00 $0 Base Case $15.00 $0 -20% -20% -10% -10% 0% 0% 10% 10% 20% 20% Deviation NPV at Different Deviations from Base from Sales Variable Base Case Units Sold Price Cost/Unit -20% $0 $0 $0 -10% $0 $0 $0 0% $0 $0 $0 10% $0 $0 $0 20% $0 $0 $0 Range $0 $0 $0

c.Now conduct a scenario analysis.Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur.There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions. (Hint: Use Scenario Manager. Go to the Data menu, choose What-If-Analyis, the choose Scenario Manager. After you create the Scenario's, you can pick a scenario and type in the resulting NPV (but be sure to return the Scenario to the base-case afterward). Or you can create a Scenario Summary and use a cell reference to the Scenario Summary worksheet to show the NPV for each scenario.) Unit Sales Sales Price per Unit Variable Costs per Unit Scenario Probability NPV Best Case 25% 2,400 $24.00 $12.00 Base Case 50% 2,000 $20.00 $15.00 Worst Case 25% 1,600 $16.00 $18.00 Expected NPV = Standard Deviation= Coefficient of Variation = Std Dev / Expected NPV = d.If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback. CV range of firm's average-risk project: 0.8 to 1.2 Low-risk WACC = 8% WACC = 10% High-risk WACC = 13% Risk-adjusted WACC = Risk adjusted NPV = IRR = Payback = e.On the basis of information in the problem, would you recommend that the project be accepted Chapter: 11 Cash Flow Estimation and Risk Analysis a.Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. Input Data (in thousands of dollars) Scenario name Base Case Note: the items in red will be used in a scenario analysis. Probability of scenario 50% Equipmentcost $25,000 Net operating working capital/Sales 12% Key Results: First year sales (in units) 2,000 NPV= Sales price per unit $21.00 IRR= Variable cost per unit (excl. depr.) $15.00 Payback = Nonvariable costs (excl. depr.) $1,500 Inflation in prices and costs 2.5% Estimated salvage value at year 4 $1,000 Depreciation years Year 1 Year 2 Year 3 Year 4 Depreciation rates 20.00% 32.00% 19.20% 11.52% Tax rate 20% WACC for average-risk projects 10% Intermediate Calculations 0 1 2 3 4 Units sold Sales price per unit (excl. depr.) Variable costs per unit (excl. depr.) Nonvariable costs (excl. depr.) Sales revenue Required level of net operating working capital Basis for depreciation Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% Annual depreciation expense Ending Bk Val: Cost - Accum Dep'rn Salvage value Profit (or loss) on salvage Tax on profit (or loss) Net cash flow due to salvage Years Cash Flow Forecast 0 1 2 3 4 Sales revenue Variable costs Nonvariable operating costs Depreciation (equipment) Oper. income before taxes (EBIT) Taxes on operating income (20%) Net operating profit after taxes Add back depreciation Equipment purchases Cash flow due to change in NOWC Net cash flow due to salvage Net Cash Flow (Time line of cash flows) Key Results:Appraisal of the Proposed Project Net Present Value (at 10%) = IRR = MIRR = Payback = Discounted Payback = Data for PaybackYears Years 0 1 2 3 4 Net cash flow Cumulative CF Part of year requiredfor payback Data for Discounted PaybackYears Years 0 1 2 3 4 Net cash flow $0 $0 $0 $0 $0 Discounted cash flow Cumulative CF Part of year required for discounted payback b.Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold.Set these variables' values at 10% and 20% above and below their base-case values. % Deviation 1st YEAR UNIT SALES Note about data tables.The data in the column input should NOT be input using a cell reference to the column input cell.For example, the base case 1st Year Unit Sales in Cell B79 should be the number 2,000 and NOT have the formula =D10 in that cell.This is because you'll use D10 as the column input cell in the data table and if Excel tries to iteratively replace Cell D10 with the formula =D10 rather than a series of numbers, Excel will calculate the wrong answer.Unfortunately, Excel won't tell you that there is a problem, so you'll just get the wrong values for the data table! from Base NPV Base Case 2,000 $0 -20% -10% 0% 10% 20% % Deviation SALES PRICE % Deviation VARIABLE COST from Base NPV from Base NPV Base Case $21.00 $0 Base Case $15.00 $0 -20% -20% -10% -10% 0% 0% 10% 10% 20% 20% Deviation NPV at Different Deviations from Base from Sales Variable Base Case Units Sold Price Cost/Unit -20% $0 $0 $0 -10% $0 $0 $0 0% $0 $0 $0 10% $0 $0 $0 20% $0 $0 $0 Range $0 $0 $0

c.Now conduct a scenario analysis.Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur.There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions. (Hint: Use Scenario Manager. Go to the Data menu, choose What-If-Analyis, the choose Scenario Manager. After you create the Scenario's, you can pick a scenario and type in the resulting NPV (but be sure to return the Scenario to the base-case afterward). Or you can create a Scenario Summary and use a cell reference to the Scenario Summary worksheet to show the NPV for each scenario.) Unit Sales Sales Price per Unit Variable Costs per Unit Scenario Probability NPV Best Case 25% 2,400 $24.00 $12.00 Base Case 50% 2,000 $20.00 $15.00 Worst Case 25% 1,600 $16.00 $18.00 Expected NPV = Standard Deviation= Coefficient of Variation = Std Dev / Expected NPV = d.If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback. CV range of firm's average-risk project: 0.8 to 1.2 Low-risk WACC = 8% WACC = 10% High-risk WACC = 13% Risk-adjusted WACC = Risk adjusted NPV = IRR = Payback = e.On the basis of information in the problem, would you recommend that the project be accepted? ?