Case Solutions for Corporate Finance Ross, Westerfield, and Jaffe 9th Edition

Case Solutions Corpo identify Finance Ross, Westerfield, and Jaffe 9th edition CHAPTER 2 CASH FLOWS AT WARF COMPUTERS The ope dictate currency liquefy for the smart set is (NOTE All numbers argon in thousands of dollars) OCF = EBIT + derogation stopover imposees OCF = $1,332 + 159 386 OCF = $1,105 To deem the gold full stop from assets, we need to let the crown spending and change in engagement works detonator.The capital spending for the twelvemonth was Capital spending terminus interlocking fixed assets $2,280 Beginning net fixed assets 1,792 + disparagement 159 win capital spending $ 647 And the change in net on the job(p) capital was win over in net work(a) capital Ending NWC $728 Beginning NWC 586 Change in NWC $142 So, the gold immix from assets was funds attend from assets Operating funds scarper $1,105 meshing capital spending 647 Change in NWC 142 Cash turn tail from assets $316 The property flow to con victionors was Cash flow to creditors Interest paying(a) $95 Net New Borrowing 20 Cash flow to Creditors $75 The coin flow to stockholders was Cash flow to stockholders Dividends paid $212 Net crude justness raised 29 Cash flow to Stockholders $241 The write up capital flow statement of cash flows for the year was Statement of Cash Flows Ope balancens Net income $742 Depreciation 159 Deferred taxes 109 Changes in assets and liabilities Accounts receivable (31) Inventories 14 Accounts payable 17 Accrued expenses (99) other(a) (9) tally cash flow from ope proportionns $902 Investing activities Acquisition of fixed assets $(786) cut-rate sale of fixed assets 139 correspond cash flow from investing activities $(547) Financing activities Retirement of debt $(98) professionalceeds of semipermanent debt 118 Notes payable 5 Dividends (212) Repurchase of stock (40) Proceeds from rude(a) stock issues 11 check cash flow from financing activities $(216) Change in cash (on repose sheet) $39 Answers to questions 1. The firm had positive earnings in an accounting sense (NI 0) and had positive cash flow from ope balancens and a positive cash flow from assets. The firm invested $142 in hot net working capital and $647 in new fixed assets.The firm was able to give in $241 to its stockholders and $75 to creditors. 2. The fiscal cash flows endow a more accu mark picture of the look out since it accu ordainly reflects absorb cash flows as a financing decision rather than an operating decision. 3. The expansion plans look like they ar belike a good idea. The guild was able to return a signifi bungholet amount of cash to its shargonholders during the year, provided a reform use of these cash flows may contract been to retain them for the expansion. This decision forget be discussed in more detail later in the restrain. CHAPTER 3 RATIOS AND FINA NCIAL PLANNING AT easternmost COAST YACHTS 1. The deliberations for the ratios listed are menses ratio = $14,651,000 / $19,539,000 Current ratio = 0. 75 measure Quick ratio = ($14,651,000 6,136,000) / $19,539,000 Quick ratio = 0. 44 measure essence asset employee employee turnover = $167,310,000 / $108,615,000 entirety asset turnover = 1. 54 clock Inventory turnover = $117,910,000 / $6,136,000 Inventory turnover = 19. 22 multiplication Receivables turnover = $167,310,000 / $5,473,000 Receivables turnover = 30. 57 times Total debt ratio = ($108,615,000 55,341,000) / $108,615,000 Total debt ratio = 0. 49 times Debt- righteousness ratio = ($19,539,000 + 33,735,000) / $55,341,000 Debt-equity ratio = 0. 96 times Equity multiplier = $108,615,000 / $55,341,000 Equity multiplier = 1. 96 timesInterest insurance coverage = $23,946,000 / $3,009,000 Interest coverage = 7. 96 times Profit valuation reserve = $12,562,200 / $167,310,000 Profit margin = 7. 51% turn in on assets = $12 ,562,200 / $108,615,000 depict on assets = 11. 57% Return on equity = $12,562,000 / $55,341,000 Return on equity = 22. 70% 2. Regarding the liquidity ratios, eastbound Coast Yachts reliable ratio is below the median perseverance ratio. This implies the gild has little liquidity than the fabrication in general. However, the legitimate ratio is above the swallow quartile, so in that location are companies in the attention with lower liquidity than tocopherol Coast Yachts. The foreshadower may deport more predictable cash flows, or more access to short-term borrowing.The turnover ratios are every higher than the patience median in fact, all three turnover ratios are above the velocity quartile. This may mean that eastward Coast Yachts is more efficient than the industry in exploitation its assets to succumb sales. The financial leverage ratios are all below the industry median, but above the lower quartile. eastside Coast Yachts generally has less debt than compar able companies, but is still within the normal range. The profit margin for the federation is about the resembling as the industry median, the ROA is middling higher than the industry median, and the roe is surface above the industry median. East Coast Yachts seems to be performing well in the profitability area.Overall, East Coast Yachts performance seems good, although the liquidity ratios indicate that a closer look may be compulsory in this area. below is a list of possible reasons it may be good or crappy that for individually(prenominal) one(pre nominative) ratio is higher or lower than the industry. Note that the list is not exhaustive, but still if one possible explanation for separately ratio. Ratio Good Bad Current ratio break down at managing menses accounts. May be having liquidity problems. Quick ratio Better at managing current accounts. May be having liquidity problems. Total asset turnover Better at utilizing assets. Assets may be older and de preciated, requiring extensive investment soon. Inventory turnover Better at inventory management, possibly overdue to Could be experiencing inventory shortages. better procedures. Receivables turnover Better at collecting receivables. May have credit terms that are too strict. Decreasing receivables turnover may ontogenesis sales. Total debt ratio slight debt than industry median means the companyIncreasing the amount of debt can increase is less presumable to accept credit problems. shareholder returns. Especially notice that it pull up stakes increase roe. Debt-equity ratio Less debt than industry median means the companyIncreasing the amount of debt can increase is less likely to welcome credit problems. shareholder returns.Especially notice that it will increase ROE. Equity multiplier Less debt than industry median means the companyIncreasing the amount of debt can increase is less likely to see to it credit problems. sharehold er returns. Especially notice that it will increase ROE. Interest coverage Less debt than industry median means the companyIncreasing the amount of debt can increase is less likely to experience credit problems. shareholder returns.Especially notice that it will increase ROE. Profit margin The PM is slightly above the industry median, soMay be able to better control woo. it is performing better than many peers. ROA Company is performing above many of its peers. Assets may be old and depreciated relative to industry. ROE Company is performing above many of its peers. Profit margin and EM could still be increased, which would save increase ROE. If you created an Inventory to Current liabilities ratio, East Coast Yachts would have a ratio that is lower than the industry median. The current ratio is below the industry median, while the quick ratio is above the industry median. This implies that East Coast Yachts has less inventory to current liabilities than the industry median. Because the cash ratio is lower than the industry median, East Coast Yachts has less inventory than the industry median, but more accounts receivable. 3.To head the internal enhanceth rate, we prototypal need to find the ROE and the retention ratio, so ROE = NI / TE ROE = $12,562,200 / $55,341,000 ROE = . 2270 or 22. 70% b = Addition to RE / NI b = $5,024,800 / $12,562,200 b = 0. 40 or 40% So, the sustainable growth rate is Sustainable growth rate = (ROE ? b) / 1 (ROE ? b) Sustainable growth rate = 0. 2270(. 40) / 1 0. 2270(. 40) Sustainable growth rate = . 0999 or 9. 99% The sustainable growth rate is the growth rate the company can achieve with no external financing while maintaining a constant debt-equity ratio. At the sustainable growth rate, the pro forma statements next year will be Income statement trades $184,018,615 COGS 129,685,224 other(a) expenses 21,990,725 Depreciation 5,460,000 EBIT $26,882,666 Interest 3,009,000 valuateable income $23,873,666 Taxes (40%) 9,549,466 Net income $14,324,199 Dividends $8,594,520 Add to RE 5,729,680 Balance sheet Assets Liabilities & Equity Current Assets Current Liabilities Cash $3,345,793 Accounts Payable $7,106,236 Accounts rec. 6,019,568 Notes Payable 14,384,050 Inventory 6,748,779 Total CL $21,490,286 Total CA $16,114,140 long-run debt $33,735,000 Shareholder Equity Common stock $5,200,000 Fixed assets carry earnings 55,870,680 Net PP&E $103,347,828 Total Equity $61,070,680 Total Assets $119,461,968 Total L&E $116,295,966 So, the EFN is EFN = Total assets Total liabilities and equity EFN = $119,461,968 116,295,966 EFN = $3,166,002 The ratios with these pro forma statements are Current ratio = $16,114,140 / $21,490,286 Current ratio = 0. 75 times Quick ratio = ($16,114,140 6,748,779) / $21,490,286 Quick ratio = 0. 44 times Total as set turnover = $184,018,615 / $119,461,968 Total asset turnover = 1. 54 times Inventory turnover = $129,685,224 / $6,748,779 Inventory turnover = 19. 22 times Receivables turnover = $184,018,615 / $6,019,568 Receivables turnover = 30. 57 timesTotal debt ratio = ($116,295,966 61,070,680) / $116,295,966 Total debt ratio = 0. 49 times Debt-equity ratio = ($21,490,286 + 33,735,000) / $61,070,680 Debt-equity ratio = 0. 90 times Equity multiplier = $119,460,968 / $61,070,680 Equity multiplier = 1. 96 times Interest coverage = $26,882,666 / $3,009,000 Interest coverage = 8. 93 times Profit margin = $14,324,199 / $184,018,615 Profit margin = 7. 78% Return on assets = $14,324,199 / $119,461,968 Return on assets = 11. 99% Return on equity = $14,324,199 / $61,070,680 Return on equity = 23. 45% The only ratios that changed are the debt ratio, the enliven coverage ratio, profit margin, return on assets, and return on equity.The debt ratio changes because long-term debt is assumed to remain fix ed in the pro forma statements. The other ratios change slightly because gratify and depreciation are also assumed to remain constant as well. 4. Pro forma financial statements for next year at a 20 percentage growth rate are Income statement Sales $200,772,000 COGS 141,492,000 Other xpenses 23,992,800 Depreciation 5,460,000 EBIT $29,827,200 Interest 3,009,000 Taxable income $26,818,200 Taxes (40%) 10,727,280 Net income $16,090,920 Dividends $9,654,552 Add to RE 6,436,368 Balance sheet Assets Liabilities & Equity Current Assets Current Liabilities Cash $3,650,400 Accounts Payable $7,753,200 Accounts rec. 6,567,600 Notes Payable 15,693,600 Inventory 7,363,200 Total CL $23,446,800 Total CA $17,581,200 semipermanent debt $33,735,000 Shareholder Equity Common stock $5,200,000 Fixed assets Retained earnings 56,577,368 Net PP&E $112,756,800 Total Equity $61,777,368 Total Assets $130,338,000 Total L&E $118,959,168 So, the EFN is EFN = Total assets Total liabilities and equity EFN = $130,338,000 118,959,168 EFN = $8,753,040 5. Now we are assuming the company can only build in amounts of $30 million. We will assume that the company will go ahead with the fixed asset acquisition. In this case, the pro forma financial statement calculation will change slightly. Before, we made the supposal that depreciation increased proportionally with sales, which makes sense if fixed assets increase proportionally with sales. This is not the case now.To estimate the new depreciation charge, we will find the current depreciation as a percentage of fixed assets, then, apply this percentage to the new fixed assets. The depreciation as a percentage of assets this year was Depreciation percentage = $5,460,000 / $93,964,000 Depreciation percentage = . 0581 or 5. 81% The new level of fixed assets with the $30 million purchase will be New fixed assets = $93,964,000 + 30,000,000 = $123,964,000 So, the pro forma depreciation as a percentage of sales will be Pro forma depreciation = . 0581($123,964,000) Pro forma depreciation = $7,203,221 We will use this amount in the pro form income statement. So, the pro forma income statement will be Income statement Sales $200,772,000 COGS 141,492,000 Other expenses 23,992,800 Depreciation 7,203,221 EBIT $28,083,979 Interest 3,009,000 Taxable income $25,074,979 Taxes (40%) 10,029,992 Net income $15,044,988 Dividends $9,026,993 Add to RE 6,017,995 The pro forma balance sheet will remain the same except for the fixed asset and equity accounts.The fixed asset account will increase by $30 million, rather than the growth rate of sales. Balance sheet Assets Liabilities & Equity Current Assets Current Liabilities Cash $3,650,400 Accounts Payable $7,753,200 Accounts rec. 6,567,600 Notes Payable 15,693,600 Inventory 7,363,200 Total CL $23,446,800 Total CA $17,581,200 Long-term debt $33,735,000 Shareholder Equity Common stock $5,200,000 Fixed assets Retained earnings 56,158,995 Net PP&E $123,964,000 Total Equity $61,358,995 Total Assets $141,545,200 Total L&E $118,540,795 So, the EFN is EFN = Total assets Total liabilities and equity EFN = $141,545,200 118,540,795 EFN = $23,004,405 Since the fixed assets have increased at a faster percentage than sales, the competency utilization for next year will decrease. CHAPTER 4 THE MBA DECISION 1. Age is obviously an important factor. The younger an individual is, the more time there is for the (hopefully) increased net income to offset the cost of the decision to return to school for an MBA. The cost includes both the explicit be such as tuition, as well as the opportunity cost of the lost fee. 2.Perhaps the most important nonquantifiable factors would be whether or not he is married and if he has any children. With a spouse and/or children, he may be less inclined to return for an MBA since his family may be less amenable to the time and money constraints imposed by classes. Other factors would include his willingness and desire to pursue an MBA, job satisfaction, and how important the prestige of a job is to him, disregardless of the compensation. 3. He has three choices remain at his current job, pursue a Wilshort ton MBA, or pursue a Mt. Perry MBA. In this analysis, room and board costs are irrelevant since presumably they will be the same whether he attends college or finds his current job.We need to find the aftertax rank of all(prenominal), so Remain at current job Aftertax allowance = $60,000(1 . 26) = $44,400 His salary will grow at 3 percent per year, so the record economic valuate of his aftertax salary is PV = C 1/(r g) 1/(r g) ? (1 + g)/(1 + r)t PV = $44,4001/(. 065 . 03) 1/(. 065 . 03) ? (1 + . 03)/(1 + . 065)40 PV = $935,283. 49 Wil ton MBA Costs The prepare costs will occur forthwith and in one year and include tuition, books and supplies, health insurance, and the room and board increase. So the total direct costs are PV of direct expenses = ($65,000 + 3,000 + 3,000 + 2,000) + ($65,000 + 3,000 + 3,000 + 2,500) / 1. 065 PV of direct expenses = $141,544. 60The indirect costs are the lost salary, so the respect of the indirect costs are PV of indirect costs (lost salary) = $44,400 / (1. 065) + $44,400(1 + . 03) / (1 + . 065)2 PV of indirect costs (lost salary) = $82,010. 18 The financial benefits are the aid to be paid in 2 geezerhood and the future salary. PV of aftertax support paid in 2 age = $20,000(1 . 31) / 1. 0652 = $12,166. 90 Aftertax salary = $10,000(1 . 31) = $75,900 His salary will grow at 4 percent per year. We must also memorialise that he will now only work for 38 long time, so the place care for of his aftertax salary is PV = C 1/(r g) 1/(r g) ? (1 + g)/(1 + r)t PV = $75,9001/(. 06 5 . 04) 1/(. 065 . 04) ? (1 + . 04)/(1 + . 065)38PV = $1,804,927. 68 Since the start-off salary payment will be received three age from forthwith, so we need to discount this for two years to find the quantify like a shot, which will be PV = $1,804,927. 68 / 1. 0652 PV = $1,591,331. 25 So, the total lever of a Wilton MBA is Value = $141,544. 60 82,010. 18 + 12,166. 90 + 1,591,331. 25 = $1,379,943. 36 Mount Perry MBA The direct costs will occur directly and include tuition, books and supplies, health insurance, and the room and board increase. So the total direct costs are Total direct costs = $80,000 + 4,500 + 3,000 + 2,000 = $89,500. Note, this is also the PV of the direct costs since they are all paid straight off.The indirect costs are the lost salary, so the observe of the indirect costs are PV of indirect costs (lost salary) = $44,400 / (1. 065) = $41,690. 14 The financial benefits are the bonus to be paid in 1 year and the future salary. PV of aftertax bonus paid in 1 year = $18,000(1 . 29) / 1. 065 = $12,000 His aftertax salary at his new job will be Aftertax salary = $80,000(1 . 29) = $65,320 His salary will grow at 3. 5 percent per year. We must also remember that he will now only work for 39 years, so the present value of his aftertax salary is PV = C 1/(r g) 1/(r g) ? (1 + g)/(1 + r)t PV = $65,3201/(. 065 . 035) 1/(. 065 . 035) ? (1 + . 035)/(1 + . 065)35 PV = $1,462,896. 46Since the first salary payment will be received two years from today, so we need to discount this for one year to find the value today, which will be PV = $1,462,896. 46 / 1. 065 PV = $1,373,611. 70 So, the total value of a Mount Perry MBA is Value = $89,500 41,690. 14 + 12,000 + 1,373,611. 70 = $1,254,421. 56 4. He is somewhat correct. Calculating the future value of each decision will result in the alternative with the highest present value having the highest future value. Thus, a future value analysis will result in the same decision. However, his state ment that a future value analysis is the correct method is wrong since a present value analysis will give the correct answer as well. 5.To find the salary offer he would need to make the Wilton MBA as financially attractive as the as the current job, we need to take the PV of his current job, add the costs of attending Wilton, and the PV of the bonus on an aftertax basis. Note, this assumes that the singing bonus is constant. So, the necessary PV to make the Wilton MBA the same as his current job will be PV = $935,283. 49 + 1414,544. 60 + 82,010. 18 12,166. 90 = $1,146,671. 37 This PV will make his current job exactly equal to the Wilton MBA on a financial basis. Since the salary will not start for 3 years, we need to find the value in 2 years so that it is the present value of growing annuity. So Value in 2 years = $1,146,671. 37(1. 0652) = $1,300,583. 34Since his salary will still be a growing annuity, the aftertax salary needed is PV = C 1/(r g) 1/(r g) ? (1 + g)/(1 + r)t $1, 300,583. 34 = C 1/(. 065 . 04) 1/(. 065 . 04) ? (1 + . 04)/(1 + . 065)38 C = $54,691. 54 This is the aftertax salary. So, the pretax salary must be Pretax salary = $54,691. 54 / (1 . 31) = $76,263. 10 6. The cost ( cheer rate) of the decision depends on the riskiness of the use of funds, not the source of the funds. Therefore, whether he can pay cash or must borrow is irrelevant. This is an important concept which will be discussed further in capital budgeting and the cost of capital in later chapters. CHAPTER 5 BULLOCK golden MINING 1.An example spreadsheet is pic 2. Since the NPV of the exploit is positive, the company should open the mine. We should note, it may be advantageous to delay the mine opening because of current options, a topic covered in more detail in a later chapter. 3. There are many possible variations on the VBA code to calculate the payback period. Below is a VBA program from http//www. vbaexpress. com/kb/getarticle. php? kb_id=252. make for PAYBACK(inve st, finflow) Dim x As two-baser, v As Double Dim c As Integer, i As Integer x = Abs(invest) i = 1 c = finflow. Count Do x = x v v = finflow. Cells(i). Value If x = v accordingly PAYBACK = i Exit Function ElseIf x v Then P = i 1Z = x / v PAYBACK = P + Z Exit Function End If i = i + 1 Loop Until i c PAYBACK = no payback End Function CHAPTER 6, Case 1 BETHESDA MINING To see this forcing out, we must calculate the incremental cash flows generated by the estimate. Since net working capital is built up ahead of sales, the sign cash flow depends in bump on this cash outflow. So, we will begin by calculating sales. Each year, the company will sell 500,000 tons under contract, and the rest on the spot grocery. The total sales revenue is the price per ton under contract times 500,000 tons, plus the spot grocery store sales times the spot market price. The sales per year will be course of instruction 1 division 2 twelvemonth 3 form 4 Contract $47,500,000 $47,500,000 $47,50 0,000 $47,500,000 Spot 10,800,000 16,200,000 20,700,000 8,100,000 Total $58,300,000 $63,700,000 $68,200,000 $55,600,000 The current aftertax value of the land is an opportunity cost. The initial outlay for net working capital is the percentage call for net working capital times Year 1 sales, or Initial net working capital = . 05($58,300,000) = $2,915,000 So, the cash flow today is Equipment $85,000,000 Land 7,000,000 NWC 2,915,000 Total $94,915,000 Now we can calculate the OCF each year. The OCF is Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Sales $58,300,000 $63,700,000 $68,200,000 $55,600,000 VC 19,220,000 21,080,000 22,630,000 18,290,000 FC 4,300,000 4,300,000 4,300,000 4,300,000 $2,800,000 $7,500,000 Dep. 12,155,000 20,825,000 14,875,000 10,625,000 EBT $22,625,000 $17,495,000 $26,395,000 $22,385,000 $2,800,000 $7,500,000 Tax 8,597,500 6,648,100 10,030,100 8,506,300 1,064,000 2,850,000 NI $14,027,500 $10,846,900 $16,364,900 $13,878,700 $1,736,000 $4,650,000 + Dep. 12,155,000 20,825,000 14,875,000 10,625,000 0 0 OCF $26,182,500 $31,671,900 $31,239,900 $24,503,700 $1,736,000 $4,650,000 Years 5 and 6 are of particular bear on. Year 5 has an expense of $2. 8 million to reclaim the land, and it is the only expense for the year.Taxes that year are a credit, an assumption given in the case. In Year 6, the charitable donation of the land is an expense, again resulting in a tax credit. The land does have an opportunity cost, but no information on the aftertax let off value of the land is provided. The implicit assumption in this calculation is that the aftertax salvage value of the land in Year 6 is equal to the $7. 5 million charitable expense. Next, we need to calculate the net working capital cash flow each year. NWC is 5 percent of next years sales, so the NWC destiny each year is Year 1 Year 2 Year 3 Year 4 Beg.NWC $2,915,000 $3,185,000 $3,410,000 $2,780,000 End NWC 3,185,000 3,410,000 2,780,000 NWC CF $270,000 $225,000 $630,000 $2,780,000 The last cash flow we need to account for is the salvage value. The fact that the company is keeping the equipment for another chore is irrelevant. The aftertax salvage value of the equipment should be used as the cost of equipment for the new chuck. In other words, the equipment could be sell after this project. Keeping the equipment is an opportunity cost associated with that project. The book value of the equipment is the original cost, minus the accumulated depreciation, or Book value of equipment = $85,000,000 12,155,000 20,825,000 14,875,000 10,625,000 Book value of equipment = $26,520,000Since the market value of the equipment is $51 million, the equipment is sold at a gain to book value, so the sale will retrieve the taxes of Taxes on sale of equipment = ($26,520,000 51,000,000)(. 38) = $9,302,400 And the aftertax salvage value of the equipment is Aftertax salvage value = $51,000,000 9,302,400 Aftertax salvage value = $41,697,600 So, t he net cash flows each year, including the operating cash flow, net working capital, and aftertax salvage value, are Time Cash flow 0 $94,915,000 1 25,912,500 2 31,446,900 3 31,869,900 4 68,981,300 5 1,736,000 6 4,650,000 So, the capital budgeting analysis for the project is Payback period = 3 + $5,685,700/$68,981,300 Payback period = 3. 08 years Profitability index = ($25,912,500/1. 12 + $31,446,900/1. 122 + $31,869,900/1. 123 + $68,981,300/1. 124 $1,736,000/1. one hundred twenty-five $4,650,000/1. 126) / $94,915,000 Profitability index = 1. 174 To calculate the AAR, we divide the intermediate net income by the average book value.Since the cash flows from the project extend for two years past the end of mining operation, we will include an average book value of zero for the last two years. So, the AAR is AAR = ($14,027,500 + 10,846,900 + 16,364,900 + 13,878,000 1,736,000 4,650,000) / 6 / (85,000,000 + 72,845,000 + 52,020,000 + 37,145,000 + 26,520,000 + 0) / 7 AAR = . 1485 or 14. 85% The equation for IRR is 0 = $94,915,000 + $25,912,500/(1 + IRR) + $31,446,900/(1 + IRR)2 + $31,869,900/(1 + IRR)3 + $68,981,300/(1 + IRR)4 $1,736,000/(1 + IRR)5 $4,650,000/(1 + IRR)6 use a spreadsheet or financial calculator, the IRRs for the project are IRR = 19. 1%, 74. 64% MIRR = 12. 94% NPV = $94,915,000 + $25,912,500/1. 12 + $31,446,900/1. 122 + $31,869,900/1. 123 + $68,981,300/1. 124 $1,736,000/1. cxxv $4,650,000/1. 126 NPV = $16,472,777. 67 In the final analysis, the company should accept the project since the NPV is positive. CHAPTER 6, Case 2 GOODWEEK TIRES, INC. The cash flow to start the project is the $120 million equipment cost and the $11 million required for net working capital, yielding a total cash outflow today of $131 million. The research and development costs and the market test are sunk costs. We can calculate the future cash flows on a titulary basis or a real basis.Since the depreciation is given in nominal values, we will calcu late the cash flows in nominal terms. The same solution can be found using real cash flows. Since the price and variable costs increase by 1 percent, and the inflation rate is 3. 5 percent, the nominal growth in both variables is (1 + R) = (1 + r)(1 + h) R = (1. 01)(1. 0325) 1 R = . 0428 or 4. 28% To analyze this project, we must calculate the incremental cash flows generated by the project. We will calculate the real cash flows, although using nominal cash flows will result in the same NPV. The sales of new automobiles will grow by 2. 5 percent per year, and there are four tires per car.Since the company expects to capture 11 percent of the market, the number of tires sold in the OEM market will be Year 1 Year 2 Year 3 Year 4 Automobiles sold 5,600,000 5,740,000 5,883,500 6,030,588 Tires for automobiles sold 22,400,000 22,960,000 23,534,000 24,122,350 SuperTread tires sold 2,464,000 2,525,600 2,588,740 2,653,459 The number of tires sold in the replacement market will grow at 2 percent per year, and Goodweek will capture 8 percent of the market. So, the number of tires sold in the replacement market will be Year 1 Year 2 Year 3 Year 4 Total tires sold in market 14,000,000 14,280,000 14,565,600 14,856,912 SuperTread tires sold 1,120,000 1,142,400 1,165,248 1,188,553 The tires will be sold in each market at a polar price. The price will increase each year at the inflation rate, so the price each year will be Year 1 Year 2 Year 3 Year 4 OEM $38. 00 $39. 24 $40. 51 $41. 83 Replacement $59. 00 $60. 92 $62. 90 $64. 94 Multiplying the number of tires sold in each market by the respective price in that market, the revenue each year will be Year 1 Year 2 Year 3 Year 4 OEM market $93,632,000 $99,091,916 $104,870,213 $110,985,458 Replacement market 66,080,000 69,592,152 73,290,975 77,186,390 Total $159,712,000 $168,684,068 $178,161,188 $188,171,848 Now we can calculate the incremental cash flows each year. We will calculate the nominal ca sh flows. Doing so, we find Year 1 Year 2 Year 3 Year 4 Revenue $159,712,000 $168,684,068 $178,161,188 $188,171,848 Variable costs 78,848,000 84,151,806 85,026,717 87,024,208 Mkt. nd general costs 26,000,000 26,845,000 27,717,463 28,618,280 Depreciation 20,020,000 34,300,000 24,500,000 17,500,000 EBT $34,844,000 $23,387,262 $40,917,008 $55,029,360 Tax 13,937,600 9,354,905 16,366,803 22,011,744 Net income $20,906,400 $14,032,357 $24,550,205 $33,017,616 OCF $40,926,400 $48,332,357 $49,050,205 $50,517,616 Net working capital is a percentage of sales, so the net working capital requirements will change every year. The net working capital cash flows will be Year 1 Year 2 Year 3 Year 4 Beginning $9,000,000 $23,956,800 $25,302,610 $26,724,178 Ending 23,956,800 25,302,610 26,724,178 0 NWC cash flow $14,956,800 $1,345,810 $1,421,568 $26,724,178 The book value of the equipment is the original cost minus the accumulated depreciation. The book value of equipment each year will be Year 1 Year 2 Year 3 Year 4 Book value of equipment $119,980,000 $85,680,000 $61,180,000 $43,680,000 Since the market value of the equipment is $54 million, the equipment is sold at a gain to book value, so the sale will incur the taxes of Taxes on sale of equipment = ($46,680,000 54,000,000)(. 40) = $4,128,000 And the aftertax salvage value of the equipment is Aftertax salvage value = $54,000,000 4,128,000 Aftertax salvage value = $89,872,000 So, the net cash flows each year, including the operating cash flow, net working capital, and aftertax salvage value, are Time Cash flow 0 $149,000,000 1 25,969,600 2 49,986,547 3 47,628,637 4 127,113,794 So, the capital budgeting analysis for the project is Payback period = 3 + $28,415,213 / $127,113,794 Payback period = 3. 22 years The discounted cash flows are Time Discounted cash flow 0 $149,000,000 1 22,406,903 2 34,978,941 3 30,592,703 4 70,446,422 Discounted payback period = 3 + $61,021 ,454 / $70,446,422 Discounted payback period = 3. 27 years The required return for the project is in nominal terms, so the profitability index is Profitability index = ($25,969,600/1. 15 + $49,986,547/1. 152 + $47,628,637/1. 153 + $96,714,733/1. 154) / $149,000,000 Profitability index = 1. 63 The equation for IRR is 0 = $149,000,000 + $25,969,600/(1 + IRR) + $49,986,547/(1 + IRR)2 + $47,628,637/(1 + IRR)3 + $96,714,733/(1 + IRR)4 Using a spreadsheet or financial calculator, the IRR for the project is IRR = 18. 35% AAR = (20,926,400 + 14,032,357 + 24,550,205 + 33,017,606)/4 / ($140,000,000 + 119,980,000 + 85,860,000 + 61,1180,000 + 43,680,000)/5 AAR = 25. 67% NPV = $149,000,000 + $25,696,600/(1. 15) + $46,986,547/(1. 15)2 + $47,628,637/(1. 15)3 + $127,113,794/(1. 15)4 NPV = $9,424,967. 81 In the final analysis, the company should accept the project since the NPV is positive. CHAPTER 7 BUNYAN LUMBER, LLCThe company is faced with the option of when to fruit the lumber. Whatever harv est home-tide cycle the company chooses, it will follow that cycle in perpetuity. Since the forest was planted 20 years ago, the options available in the case are 40-, 45-, 50, and 55-year harvest cycles. No enumerate what harvest cycle the company chooses, it will always thin the look 20 years after harvests and replants. The cash flows will grow at the inflation rate, so we can use the real or nominal cash flows. In this case, it is simpler to use real cash flows, although nominal cash flows would yield the same result. So, the real required return on the project is (1 + R) = (1 + r)(1 + h) 1. 10 = (1 + r)(1. 37) r = . 0608 or 6. 08% The preservation funds are expected to grow at a slower rate than inflation, so the real return for the saving fund will be (1 + R) = (1 + r)(1 + h) 1. 10 = (1 + r)(1. 032) r = . 0659 or 6. 59% The company will thin the forest today regardless of the harvest inscription, so this first carving is not an incremental cash flow, but future thinning i s part of the analysis since the thinning muniment is determined by the harvest schedule. The cash flow from the thinning process is Cash flow from thinning = Acres thinned ? Cash flow per acre Cash flow from thinning = 5,000($1,000) Cash flow from thinning = $5,000,000The real cost of the conservation fund is constant, but the expense will be tax deductible, so the aftertax cost of the conservation fund will be Aftertax conservation fund cost = (1 . 35)($250,000) Aftertax conservation fund cost = $162,500 For each analysis, the revenue and costs are Revenue = ? (% of grade)(harvest per acre)(value of board grade)(acres harvested)(1 defect rate) Tractor cost = (Cost MBF)(MBF per acre)(acres) Road cost = (Cost MBF)(MBF per acre)(acres) Sale preparation and administration = (Cost MBF)(MBF acre)(acres) Excavator piling, broadcast earnest, site preparation, and planting costs are the cost of each per acre times the number of acres.These costs are the same no matter what the harvest schedule since they are based on acres, not MBF. Now we can calculate the cash flow for each harvest schedule. One important note is that no depreciation is given in the case. Since the harvest time is likely to be short, the assumption is that no depreciation is attributable to the harvest. This implies that operating cash flow is equal to net income. Now we can calculate the NPV of each harvest schedule. The NPV of each harvest schedule is the NPV of the first harvest, the NPV of the thinning, the NPV of all future harvests, minus the present value of the conservation fund costs. 40-year harvest schedule Revenue $42,194,250 Tractor cost 9,870,000 Road 3,525,000 Sale preparation & admin 1,269,000 Excavator piling 750,000 Broadcast intense 1,500,000 Site preparation 725,000 Planting costs 1,125,000 EBIT $23,430,250 Taxes 8,200,588 Net income (OCF) $15,229,663 The PV of the first harvest in 20 years is PVFirst = $15,229,663/(1 + . 0608)20 PVFirst = $4,681,788T hinning will also occur on a 40-year schedule, with the next thinning 40 years from today. The effective 40-year enkindle rate for the project is 40-year project interest rate = (1 + . 0608)40 1 40-year project interest rate = 958. 17% We also need the 40-year interest rate for the conservation fund, which will be 40-year conservation interest rate = (1 + . 0659)40 1 40-year conservation interest rate = 1,183. 87% Since we have the cash flows from each thinning, and the next thinning will occur in 40 years, we can find the present value of future thinning on this schedule, which will be PVThinning = $5,000,000/9. 5817 PVThinning = $521,825. 80The operating cash flow from each harvest on the 40-year schedule is $15,229,663, so the present value of the cash flows from the harvest are PVHarvest = ($15,229,663/9. 5817) / (1 + . 0608)20 PVHarvest = $488,615. 51 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 20 is PVC onservation = $162,500 $162,500/11. 8387 PVConservation = $176,226. 22 And the value today is PVConservation = $175,226. 22/(1 + . 0659)20 PVConservation = $49,182. 52 So, the NPV of a 40-year harvest schedule is NPV = $4,681,788 + 521,825. 80 + 488,615. 51 49,182. 52 NPV = $5,643,046. 36 45-year harvest schedule Revenue $49,232,800 Tractor cost 11,480,000 Road 4,100,000 Sale preparation & admin 1,476,000 Excavator piling 750,000 Broadcast burning 1,500,000 Site preparation 725,000 Planting costs 1,125,000 EBIT $28,076,800 Taxes 9,826,880 Net income (OCF) $18,249,920 The PV of the first harvest in 25 years is PVFirst = $18,249,920/(1 + . 0608)25 PVFirst = $4,177,464Thinning will also occur on a 45-year schedule, with the next thinning 45 years from today. The effective 45-year interest rate for the project is 45-year project interest rate = (1 + . 0608)45 1 45-year project interest rate = 1,321. 11% We also need the 45-year interest rate for the conservation fund, which will be 45-year conservation interest rate = (1 + . 0659)45 1 45-year conservation interest rate = 1,666. 38% Since we have the cash flows from each thinning, and the next thinning will occur in 45 years, we can find the present value of future thinning on this schedule, which will be PVThinning = $5,000,000/13. 2111 PVThinning = $378,470. 46The operating cash flow from each harvest on the 45-year schedule is $18,249,920, so the present value of the cash flows from the harvest are PVHarvest = ($18,249,920/13. 21111) / (1 + . 0608)25 PVHarvest = $316,209. 37 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 25 is PVConservation = $162,500 $162,500/16. 6638 PVConservation = $174,800. 29 And the value today is PVConservation = $174,800. 29/(1 + . 0659)25 PVConservation = $35,458. 26 So, the NPV of a 45-year harvest schedule is NPV = $4,177,464 + 378,470. 46 + 316,209. 37 35,458. 26 NPV = $4,836,685. 86 50 -year harvest schedule Revenue $52,024,993 Tractor cost 12,110,000 Road 4,325,000 Sale preparation & admin 1,557,000 Excavator piling 750,000 Broadcast burning 1,500,000 Site preparation 725,000 Planting costs 1,125,000 EBIT $29,932,993 Taxes 10,476,547 Net income (OCF) $19,456,445 The PV of the first harvest in 30 years is PVFirst = $19,456,445/(1 + . 0608)30 PVFirst = $3,316,238Thinning will also occur on a 50-year schedule, with the next thinning 50 years from today. The effective 50-year interest rate for the project is 50-year project interest rate = (1 + . 0608)50 1 50-year project interest rate = 1,808. 52% We also need the 50-year interest rate for the conservation fund, which will be 50-year conservation interest rate = (1 + . 0659)50 1 50-year conservation interest rate = 2,330. 24% Since we have the cash flows from each thinning, and the next thinning will occur in 50 years, we can find the present value of future thinning on this schedule, which w ill be PVThinning = $5,000,000/18. 0852 PVThinning = $276,468. 34The operating cash flow from each harvest on the 50-year schedule is $19,456,445, so the present value of the cash flows from the harvest are PVHarvest = ($19,456,445/18. 0852 / (1 + . 0608)30 PVHarvest = $183,367. 60 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 30 is PVConservation = $162,500 $162,500/23. 3024 PVConservation = $171,485. 25 And the value today is PVConservation = $171,485. 25/(1 + . 0659)30 PVConservation = $25,283. 50 So, the NPV of a 50-year harvest schedule is NPV = $3,316,238 + 276,469. 34 + 183,367. 60 25,283. 50 NPV = $3,750,790. 98 55-year harvest schedule Revenue $54,516,748 Tractor cost 12,670,000 Road 4,525,000 Sale preparation & admin 1,629,000 Excavator piling 750,000 Broadcast burning 1,500,000 Site preparation 725,000 Planting costs 1,125,000 EBIT $31,592,748 Taxes 11,057,462 Net income (OCF) $20 ,535,286 The PV of the first harvest in 35 years is PVFirst = $20,535,286/(1 + . 0608)35 PVFirst = $2,606,233 Thinning will also occur on a 55-year schedule, with the next thinning 55 years from today. The effective 55-year interest rate for the project is 55-year project interest rate = (1 + . 0608)55 1 55-year project interest rate = 2,463. 10 We also need the 55-year interest rate for the conservation fund, which will be 55-year conservation interest rate = (1 + . 0659)55 1 55-year conservation interest rate = 3,243. 60%Since we have the cash flows from each thinning, and the next thinning will occur in 55 years, we can find the present value of future thinning on this schedule, which will be PVThinning = $5,000,000/24. 6310 PVThinning = $202,995. 97 The operating cash flow from each harvest on the 55-year schedule is $20,535,286, so the present value of the cash flows from the harvest are PVHarvest = ($20,535,286/24. 6310 / (1 + . 0608)35 PVHarvest = $105,810. 96 Now we can f ind the present value of the conservation fund deposits. The present value of these deposits is at Year 35 is PVConservation = $162,500 $162,500/32. 4360 PVConservation = $169,097. 37 And the value today is PVConservation = $169,097. 37/(1 + . 0659)35 PVConservation = $18,121. 00 So, the NPV of a 55-year harvest schedule isNPV = $2,606,233 + 202,995. 97 + 105,810. 96 18,121. 00 NPV = $2,896,918. 96 The company should use a 40-year harvest schedule since it has the highest NPV. Notice that when the NPV began to decline, it continued declining. This is expected since the growth in the trees increases at a change magnitude rate. So, once we reach a point where the increased growth cannot overcome the increased effects of compounding, pull together should take place. There is no point further in the future which will provide a higher NPV. CHAPTER 8 FINANCING EAST COAST YACHTS EXPANSION PLANS WITH A amaze ISSUE 1. A rule of thumb with bind provisions is to determine who the provisi ons benefit.If the company benefits, the bond will have a higher coupon rate. If the bondholders benefit, the bond will have a lower coupon rate. a. A bond with positive will have a lower coupon rate. Bondholders have the claim on the collateral, even in bankruptcy. Collateral provides an asset that bondholders can claim, which lowers their risk in default. The downside of collateral is that the company generally cannot sell the asset used as collateral, and they will generally have to keep the asset in good working order. b. The more senior the bond is, the lower the coupon rate. aged(a) bonds get full payment in bankruptcy proceedings before subordinated bonds receive any payment.A potential problem may arise in that the bond covenant may restrict the company from issuing any future bonds senior to the current bonds. c. A sinking fund will void the coupon rate because it is a partial guarantee to bondholders. The problem with a sinking fund is that the company must make the int erim payments into a sinking fund or face default. This means the company must be able to generate these cash flows. d. A provision with a specific call date and prices would increase the coupon rate. The call provision would only be used when it is to the companys advantage, thus the bondholders disadvantage. The downside is the higher coupon rate.The company b