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To illustrate and further support our strategic financial planning systems we need to show the CFO and management team an example of the application of the previously constructed WACC. The CFO thinks that showing management how we can validate and choose projects based on expected returns developed from the WACC will help reduce risk of our investor’s capital thus lowering the required rate of return we would have to provide to those investors. If we lower our expected return we can then do more projects and grow at a faster rate.
He has asked your team to evaluate the following project:
Capital investment: Acme is planning construction of a new loading ramp for its single iron mill. The initial cost of the investment is $1 million. Efficiencies from the new ramp are expected to reduce costs by $100,000 for the life of the plant which is currently estimated at another 30 years. When will this project break-even on a simple cash basis and a discounted cash basis. What is the NPV of the project if Acme has an after tax cost of debt of 8% and a cost equity of 12% (they are currently funded equally by debt and equity)?
Concept Check: We need to adjust cash flows to account for things like inflation, our cost of capital and opportunity costs. Simply looking at cash flow not adjusted for some of these costs will lead to taking on projects which are not really adding to the value of the organization.
Helpful Hint: The first step in conducting an NPV analysis is to include all the relevant cash flows. This includes savings from taxes and any expenses directly related to the venture. We reject any project with a negative NPV.
Consider a bond with 5 years left to maturity, paying a coupon of 12%. The par value is 80% collateralized by American Treasury bonds. Assume that the U.S. interest rate is 5% for all maturities. What is the price of a bond with $100 par?
A firm can produce 100 units per week. If its total cost function is C = 500 + 1500x dollars and its total revenue function is R = 1600x-x2 dollars, how many units, x, should it produce to maximize its profit? Find the maximum profit.
Deriving forecasts of the future spot rate. Use the forward rate to forecast the percentage change in the Mexican peso over the next year.
An investor sold seven contracts of June/2012 corn. The price per bushel was $1.64, and each contract was for 5000 bushels. The initial margin deposit is $2000 per contract with the maintenance margin at $1250. How much did the investor have to depos..
BUACC3701: Financial Management - Evaluate the alternative capital investments. Justify your answers to the following questions with full explanations.
The patterson Hale Trucking Company needs to expand it fleet by 90% to meet the demands of 2 major contracts, the cost of expansion is estmated to be $15 million. PHT maintains a 30 % debt ratio and pays out 90% of its earnings in common stock divide..
Muntjac Corporation's flexible budget cost formula for indirect materials, a variable cost, is $0.75 per unit of output. Assume that actual units produced equals standard units produced. If the company's performance report for last month shows a $250..
Which one of the following comparisons between debt and equity is correct?
A corporate bond with a 5.75 percent coupon has 15 years left to maturity. It has had a credit rating of BB and a yield to maturity of 6.25 percent. The firm has recently gotten more financially stable and the rating agency is upgrading the bonds to ..
Janicex Co. is growing quickly. Dividends are expected to grow at a rate of 24 percent for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 11 percent and the company just paid a div..
The management of Brinkley Corporation is interested in using simulation to estimate the profit per unit for a new product. The selling price for the product will be $45 per unit. Compute profit per unit for the base-case, worst-case, and best-case s..
We are evaluating a project that costs $119453, has a seven-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 4219 units per year. Suppose the projections given..
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