Finance: HOMEWORK Spring 2013

THE BOOK USED

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

IN THESE

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

FORMAT: You

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

Worked Problems

for Partial Credit

1.

(10) During the course of your education,

you have borrowed $65,000 in student loans.

You plan to make monthly payments in order to repay the debt.
The interest rate is fixed at 6.8% APR

(compounding is monthly). SHOW

YOUR WORK

a.

If the loan is for 10 years, find the

monthly payment.

b.

Right after your 38th payment,

you get a huge bonus and decide to pay off the loan. How much
do you still owe?

c.

Find the effective rate on the loan.

2.

(10) Starbucks has one debt issue outstanding. The debt
matures on August 15, 2017, and has

a 6.25% coupon. Coupons are paid

semiannually. The bond is priced to

yield 1.61% compound semiannually. The

bond has a face value of $1000. SHOW

YOUR WORK

a.

Estimate the price of the bond on February 15, 2013,
immediately

after that coupon is paid.

b.

You buy the bond on February 15, 2013 for your estimated
price

from part a. You sell the bond 1 year

later for $1160. What was your return?

Why is it different from the original yield to maturity?
Assume you collect 2 coupon payments.

3.

(10) You have the following information for

Starbucks: Current EPS is $1.79. The

current dividend is $.68 per share. The

return on equity is 24%. The current

price is $49.22. Hint: Get the payout

rate.

a.

Use the dividend discount model (also known as the constant
growth

model) to estimate the return for Starbucks.

SHOW YOUR WORK

b.

Assuming

your answer to part a. is correct, estimate the present value
of the growth

opportunities (PVGO). SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

THE BOOK USED

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

IN THESE

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

FORMAT: You

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

4.

(10) Tank Industries Washers expects to pay the following

dividends over the next 4 years: $2.50, $3.20, $4.75 and
$5.20 respectively

(starting at time 1). SHOW

YOUR WORK

a. After year 4, the firm expects a

constant growth rate of 3%. If investors

require 11%, what is the current share price?

b. The CEO, Major Payne, has identified

several new investment opportunities. He

is trying to convince investors to back his strategy. He
would need to keep the dividends at $2.50

each year for the next four years. After year 4, the growth
rate would be 10%

forever. Based on the increased risk,

the other investors increase the required return to 15%.
Should they back his strategy? Hint: Re-estimate

the current price based on the new cash flows. SHOW

YOUR WORK

5.

(10) BAC is considering an issue of

preferred stock. The dividends are 8.12%

of the $25 par value.

a.

If the current price is $26.25 per share,

what is the return on the preferred stock?

b.

Suppose the preferred stock will mature in 20 years. If the
price is $26.25 per share, what is the

return on the preferred stock? HINT: This is just like a
bond, but the face

value is 25. For the problem, you can

assume the dividends are annual. SHOW

YOUR WORK

6.

(10) One use of cash flow analysis is setting the bid price
on a

project. To calculate the bid price, we set the project NPV
equal to zero and

find the required price. Thus the bid price represents a
financial break-even

level for the project. Guthrie Enterprises needs someone to
supply it with

230,000 cartons of machine screws per year to support its
manufacturing needs

over the next five years, and you’ve decided to bid on the
contract. It will

cost you $1,000,000 to install the equipment necessary to
start production;

you’ll depreciate this cost straight-line to zero over the
project’s life. Your

fixed production costs will be $410,000 per year, and your
variable production

costs should be $8.50 per carton. You also need an initial
investment in net

working capital of $60,000. No additional

working capital is needed and no working capital will be
returned. If your tax rate is 35% and you require a 14%

return on your investment, what bid price should you submit?

SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

THE BOOK USED

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

IN THESE

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

FORMAT: You

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

7.

(14) Cupcake Corp. is considering an investment of $40
million in

plant and machinery. This is expected to

produce sales of $23 million in year 1, $26 million in year
2, and $30 million

in year 3. Subsequent sales are expected

to increase by 10% each year for the remaining 2 years. The
plant and machinery will be scrapped

after 5 years with a salvage value of $10 million. The
property and machinery belong to the 3‑year

recovery period class for depreciation purposes (MACRS). Cost
of goods sold (COGS) is expected to be

$8 million in year 1, $14 million in year 2, and to increase
at 9% each year

for the remaining 3 years. Fixed

operating expenses are $1,000,000 per year.

Year-end net working capital (NWC) is given below. The
corporate tax rate is 40%.

k = 000s

0

1

2

3

4

5

NWC

500k

700k

800k

800k

500k

0

a) Calculate the free cash flows for time

0 through time 5. SHOW YOUR WORK

b) Calculate the net present value (NPV)

for a 12% cost of capital. SHOW YOUR WORK

c) Find the internal rate of return

(IRR). SHOW YOUR WORK

d) Calculate the sensitivity of the

investment to a change in the cost of capital (it could be as
low as 8% or as

high as 16%). SHOW

YOUR WORK

e) Should Cupcake make the

investment? Why or why not? SHOW YOUR WORK

Comments:

·

You need to consider the added

investment in net working capital (NWC) for each period. The
problem gives the total amount of NWC for

that period. Cupcake initially invests

$500,000 in NWC. At the end of the first

year, NWC increases to 600,000 so the firm has increased its
investment in NWC

by $100,000. This process continues over

the project’s life until all of the NWC is returned in last
year.

·

Taxes:

The project is part of a larger firm, so any operating losses
can be used to

offset gains in other areas. This would

produce a tax savings for that year.

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

Worked Problems

for Partial Credit

1.

(10) During the course of your education,

you have borrowed $65,000 in student loans.

You plan to make monthly payments in order to repay the debt.
The interest rate is fixed at 6.8% APR

(compounding is monthly). SHOW

YOUR WORK

a.

If the loan is for 10 years, find the

monthly payment.

b.

Right after your 38th payment,

you get a huge bonus and decide to pay off the loan. How much
do you still owe?

c.

Find the effective rate on the loan.

2.

(10) Starbucks has one debt issue outstanding. The debt
matures on August 15, 2017, and has

a 6.25% coupon. Coupons are paid

semiannually. The bond is priced to

yield 1.61% compound semiannually. The

bond has a face value of $1000. SHOW

YOUR WORK

a.

Estimate the price of the bond on February 15, 2013,
immediately

after that coupon is paid.

b.

You buy the bond on February 15, 2013 for your estimated
price

from part a. You sell the bond 1 year

later for $1160. What was your return?

Why is it different from the original yield to maturity?
Assume you collect 2 coupon payments.

3.

(10) You have the following information for

Starbucks: Current EPS is $1.79. The

current dividend is $.68 per share. The

return on equity is 24%. The current

price is $49.22. Hint: Get the payout

rate.

a.

Use the dividend discount model (also known as the constant
growth

model) to estimate the return for Starbucks.

SHOW YOUR WORK

b.

Assuming

your answer to part a. is correct, estimate the present value
of the growth

opportunities (PVGO). SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

4.

(10) Tank Industries Washers expects to pay the following

dividends over the next 4 years: $2.50, $3.20, $4.75 and
$5.20 respectively

(starting at time 1). SHOW

YOUR WORK

a. After year 4, the firm expects a

constant growth rate of 3%. If investors

require 11%, what is the current share price?

b. The CEO, Major Payne, has identified

several new investment opportunities. He

is trying to convince investors to back his strategy. He
would need to keep the dividends at $2.50

each year for the next four years. After year 4, the growth
rate would be 10%

forever. Based on the increased risk,

the other investors increase the required return to 15%.
Should they back his strategy? Hint: Re-estimate

the current price based on the new cash flows. SHOW

YOUR WORK

5.

(10) BAC is considering an issue of

preferred stock. The dividends are 8.12%

of the $25 par value.

a.

If the current price is $26.25 per share,

what is the return on the preferred stock?

b.

Suppose the preferred stock will mature in 20 years. If the
price is $26.25 per share, what is the

return on the preferred stock? HINT: This is just like a
bond, but the face

value is 25. For the problem, you can

assume the dividends are annual. SHOW

YOUR WORK

6.

(10) One use of cash flow analysis is setting the bid price
on a

project. To calculate the bid price, we set the project NPV
equal to zero and

find the required price. Thus the bid price represents a
financial break-even

level for the project. Guthrie Enterprises needs someone to
supply it with

230,000 cartons of machine screws per year to support its
manufacturing needs

over the next five years, and you’ve decided to bid on the
contract. It will

cost you $1,000,000 to install the equipment necessary to
start production;

you’ll depreciate this cost straight-line to zero over the
project’s life. Your

fixed production costs will be $410,000 per year, and your
variable production

costs should be $8.50 per carton. You also need an initial
investment in net

working capital of $60,000. No additional

working capital is needed and no working capital will be
returned. If your tax rate is 35% and you require a 14%

return on your investment, what bid price should you submit?

SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

7.

(14) Cupcake Corp. is considering an investment of $40
million in

plant and machinery. This is expected to

produce sales of $23 million in year 1, $26 million in year
2, and $30 million

in year 3. Subsequent sales are expected

to increase by 10% each year for the remaining 2 years. The
plant and machinery will be scrapped

after 5 years with a salvage value of $10 million. The
property and machinery belong to the 3‑year

recovery period class for depreciation purposes (MACRS). Cost
of goods sold (COGS) is expected to be

$8 million in year 1, $14 million in year 2, and to increase
at 9% each year

for the remaining 3 years. Fixed

operating expenses are $1,000,000 per year.

Year-end net working capital (NWC) is given below. The
corporate tax rate is 40%.

k = 000s

0

1

2

3

4

5

NWC

500k

700k

800k

800k

500k

0

a) Calculate the free cash flows for time

0 through time 5. SHOW YOUR WORK

b) Calculate the net present value (NPV)

for a 12% cost of capital. SHOW YOUR WORK

c) Find the internal rate of return

(IRR). SHOW YOUR WORK

d) Calculate the sensitivity of the

investment to a change in the cost of capital (it could be as
low as 8% or as

high as 16%). SHOW

YOUR WORK

e) Should Cupcake make the

investment? Why or why not? SHOW YOUR WORK

Comments:

·

You need to consider the added

investment in net working capital (NWC) for each period. The
problem gives the total amount of NWC for

that period. Cupcake initially invests

$500,000 in NWC. At the end of the first

year, NWC increases to 600,000 so the firm has increased its
investment in NWC

by $100,000. This process continues over

the project’s life until all of the NWC is returned in last
year.

·

Taxes:

The project is part of a larger firm, so any operating losses
can be used to

offset gains in other areas. This would

produce a tax savings for that year.

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

Worked Problems

for Partial Credit

1.

(10) During the course of your education,

you have borrowed $65,000 in student loans.

You plan to make monthly payments in order to repay the debt.
The interest rate is fixed at 6.8% APR

(compounding is monthly). SHOW

YOUR WORK

a.

If the loan is for 10 years, find the

monthly payment.

b.

Right after your 38th payment,

you get a huge bonus and decide to pay off the loan. How much
do you still owe?

c.

Find the effective rate on the loan.

2.

(10) Starbucks has one debt issue outstanding. The debt
matures on August 15, 2017, and has

a 6.25% coupon. Coupons are paid

semiannually. The bond is priced to

yield 1.61% compound semiannually. The

bond has a face value of $1000. SHOW

YOUR WORK

a.

Estimate the price of the bond on February 15, 2013,
immediately

after that coupon is paid.

b.

You buy the bond on February 15, 2013 for your estimated
price

from part a. You sell the bond 1 year

later for $1160. What was your return?

Why is it different from the original yield to maturity?
Assume you collect 2 coupon payments.

3.

(10) You have the following information for

Starbucks: Current EPS is $1.79. The

current dividend is $.68 per share. The

return on equity is 24%. The current

price is $49.22. Hint: Get the payout

rate.

a.

Use the dividend discount model (also known as the constant
growth

model) to estimate the return for Starbucks.

SHOW YOUR WORK

b.

Assuming

your answer to part a. is correct, estimate the present value
of the growth

opportunities (PVGO). SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

4.

(10) Tank Industries Washers expects to pay the following

dividends over the next 4 years: $2.50, $3.20, $4.75 and
$5.20 respectively

(starting at time 1). SHOW

YOUR WORK

a. After year 4, the firm expects a

constant growth rate of 3%. If investors

require 11%, what is the current share price?

b. The CEO, Major Payne, has identified

several new investment opportunities. He

is trying to convince investors to back his strategy. He
would need to keep the dividends at $2.50

each year for the next four years. After year 4, the growth
rate would be 10%

forever. Based on the increased risk,

the other investors increase the required return to 15%.
Should they back his strategy? Hint: Re-estimate

the current price based on the new cash flows. SHOW

YOUR WORK

5.

(10) BAC is considering an issue of

preferred stock. The dividends are 8.12%

of the $25 par value.

a.

If the current price is $26.25 per share,

what is the return on the preferred stock?

b.

Suppose the preferred stock will mature in 20 years. If the
price is $26.25 per share, what is the

return on the preferred stock? HINT: This is just like a
bond, but the face

value is 25. For the problem, you can

assume the dividends are annual. SHOW

YOUR WORK

6.

(10) One use of cash flow analysis is setting the bid price
on a

project. To calculate the bid price, we set the project NPV
equal to zero and

find the required price. Thus the bid price represents a
financial break-even

level for the project. Guthrie Enterprises needs someone to
supply it with

230,000 cartons of machine screws per year to support its
manufacturing needs

over the next five years, and you’ve decided to bid on the
contract. It will

cost you $1,000,000 to install the equipment necessary to
start production;

you’ll depreciate this cost straight-line to zero over the
project’s life. Your

fixed production costs will be $410,000 per year, and your
variable production

costs should be $8.50 per carton. You also need an initial
investment in net

working capital of $60,000. No additional

working capital is needed and no working capital will be
returned. If your tax rate is 35% and you require a 14%

return on your investment, what bid price should you submit?

SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

7.

(14) Cupcake Corp. is considering an investment of $40
million in

plant and machinery. This is expected to

produce sales of $23 million in year 1, $26 million in year
2, and $30 million

in year 3. Subsequent sales are expected

to increase by 10% each year for the remaining 2 years. The
plant and machinery will be scrapped

after 5 years with a salvage value of $10 million. The
property and machinery belong to the 3‑year

recovery period class for depreciation purposes (MACRS). Cost
of goods sold (COGS) is expected to be

$8 million in year 1, $14 million in year 2, and to increase
at 9% each year

for the remaining 3 years. Fixed

operating expenses are $1,000,000 per year.

Year-end net working capital (NWC) is given below. The
corporate tax rate is 40%.

k = 000s

0

1

2

3

4

5

NWC

500k

700k

800k

800k

500k

0

a) Calculate the free cash flows for time

0 through time 5. SHOW YOUR WORK

b) Calculate the net present value (NPV)

for a 12% cost of capital. SHOW YOUR WORK

c) Find the internal rate of return

(IRR). SHOW YOUR WORK

d) Calculate the sensitivity of the

investment to a change in the cost of capital (it could be as
low as 8% or as

high as 16%). SHOW

YOUR WORK

e) Should Cupcake make the

investment? Why or why not? SHOW YOUR WORK

Comments:

·

You need to consider the added

investment in net working capital (NWC) for each period. The
problem gives the total amount of NWC for

that period. Cupcake initially invests

$500,000 in NWC. At the end of the first

year, NWC increases to 600,000 so the firm has increased its
investment in NWC

by $100,000. This process continues over

the project’s life until all of the NWC is returned in last
year.

·

Taxes:

The project is part of a larger firm, so any operating losses
can be used to

offset gains in other areas. This would

produce a tax savings for that year.

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

for Partial Credit

1.

(10) During the course of your education,

you have borrowed $65,000 in student loans.

You plan to make monthly payments in order to repay the debt.
The interest rate is fixed at 6.8% APR

(compounding is monthly). SHOW

YOUR WORK

a.

If the loan is for 10 years, find the

monthly payment.

b.

Right after your 38th payment,

you get a huge bonus and decide to pay off the loan. How much
do you still owe?

c.

Find the effective rate on the loan.

(10) Starbucks has one debt issue outstanding. The debt
matures on August 15, 2017, and has

a 6.25% coupon. Coupons are paid

semiannually. The bond is priced to

yield 1.61% compound semiannually. The

bond has a face value of $1000. SHOW

YOUR WORK

a.

Estimate the price of the bond on February 15, 2013,
immediately

after that coupon is paid.

b.

You buy the bond on February 15, 2013 for your estimated
price

from part a. You sell the bond 1 year

later for $1160. What was your return?

Why is it different from the original yield to maturity?
Assume you collect 2 coupon payments.

(10) You have the following information for

Starbucks: Current EPS is $1.79. The

current dividend is $.68 per share. The

return on equity is 24%. The current

price is $49.22. Hint: Get the payout

rate.

a.

Use the dividend discount model (also known as the constant
growth

model) to estimate the return for Starbucks.

SHOW YOUR WORK

b.

Assuming

your answer to part a. is correct, estimate the present value
of the growth

opportunities (PVGO). SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

(10) Tank Industries Washers expects to pay the following

dividends over the next 4 years: $2.50, $3.20, $4.75 and
$5.20 respectively

(starting at time 1). SHOW

YOUR WORK

a. After year 4, the firm expects a

constant growth rate of 3%. If investors

require 11%, what is the current share price?

b. The CEO, Major Payne, has identified

several new investment opportunities. He

is trying to convince investors to back his strategy. He
would need to keep the dividends at $2.50

each year for the next four years. After year 4, the growth
rate would be 10%

forever. Based on the increased risk,

the other investors increase the required return to 15%.
Should they back his strategy? Hint: Re-estimate

the current price based on the new cash flows. SHOW

YOUR WORK

(10) BAC is considering an issue of

preferred stock. The dividends are 8.12%

of the $25 par value.

a.

If the current price is $26.25 per share,

what is the return on the preferred stock?

b.

Suppose the preferred stock will mature in 20 years. If the
price is $26.25 per share, what is the

return on the preferred stock? HINT: This is just like a
bond, but the face

value is 25. For the problem, you can

assume the dividends are annual. SHOW

YOUR WORK

(10) One use of cash flow analysis is setting the bid price
on a

project. To calculate the bid price, we set the project NPV
equal to zero and

find the required price. Thus the bid price represents a
financial break-even

level for the project. Guthrie Enterprises needs someone to
supply it with

230,000 cartons of machine screws per year to support its
manufacturing needs

over the next five years, and you’ve decided to bid on the
contract. It will

cost you $1,000,000 to install the equipment necessary to
start production;

you’ll depreciate this cost straight-line to zero over the
project’s life. Your

fixed production costs will be $410,000 per year, and your
variable production

costs should be $8.50 per carton. You also need an initial
investment in net

working capital of $60,000. No additional

working capital is needed and no working capital will be
returned. If your tax rate is 35% and you require a 14%

return on your investment, what bid price should you submit?

SHOW YOUR WORK

Finance: HOMEWORK Spring 2013

FOR THIS ASSIGNMENT IS ROSS, JAFFE AND WESTERFIELD AND JAFFE,
CORPORATE

FINANCE, 9th Edition

PROBLEMS,

All

payments occur at the end of the period unless stated
otherwise.

Interest is compounded annually unless stated

otherwise.

Face

value of all bonds is $1000.

can use a Word document, an Excel spreadsheet or both. Please
do not embed Excel into a Word

document. Please use

single-spaced, 11 pt. or 12 pt. font.

——————————————————————————————————————————————

(14) Cupcake Corp. is considering an investment of $40
million in

plant and machinery. This is expected to

produce sales of $23 million in year 1, $26 million in year
2, and $30 million

in year 3. Subsequent sales are expected

to increase by 10% each year for the remaining 2 years. The
plant and machinery will be scrapped

after 5 years with a salvage value of $10 million. The
property and machinery belong to the 3‑year

recovery period class for depreciation purposes (MACRS). Cost
of goods sold (COGS) is expected to be

$8 million in year 1, $14 million in year 2, and to increase
at 9% each year

for the remaining 3 years. Fixed

operating expenses are $1,000,000 per year.

Year-end net working capital (NWC) is given below. The
corporate tax rate is 40%.

k = 000s

0

1

2

3

4

5

NWC

500k

700k

800k

800k

500k

0

0 through time 5. SHOW YOUR WORK

b) Calculate the net present value (NPV)

for a 12% cost of capital. SHOW YOUR WORK

c) Find the internal rate of return

(IRR). SHOW YOUR WORK

d) Calculate the sensitivity of the

investment to a change in the cost of capital (it could be as
low as 8% or as

high as 16%). SHOW

YOUR WORK

e) Should Cupcake make the

investment? Why or why not? SHOW YOUR WORK

·

You need to consider the added

investment in net working capital (NWC) for each period. The
problem gives the total amount of NWC for

that period. Cupcake initially invests

$500,000 in NWC. At the end of the first

year, NWC increases to 600,000 so the firm has increased its
investment in NWC

by $100,000. This process continues over

the project’s life until all of the NWC is returned in last
year.

·

Taxes:

The project is part of a larger firm, so any operating losses
can be used to

offset gains in other areas. This would

produce a tax savings for that year.