# FINANCE-THE BOOK USED FOR THIS ASSIGNMENT IS ROSS,

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
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
a.
If the loan is for 10 years, find the
monthly payment.
b.
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
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.
b.
Assuming
your answer to part a. is correct, estimate the present value of the growth

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
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
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

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

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?

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
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
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
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.

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
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
a.
If the loan is for 10 years, find the
monthly payment.
b.
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
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.
b.
Assuming
your answer to part a. is correct, estimate the present value of the growth

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
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
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

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

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?

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
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
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
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.

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
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
a.
If the loan is for 10 years, find the
monthly payment.
b.
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
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.
b.
Assuming
your answer to part a. is correct, estimate the present value of the growth

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
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
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

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

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?

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
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
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
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.

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
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
a.
If the loan is for 10 years, find the
monthly payment.
b.
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
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.
b.
Assuming
your answer to part a. is correct, estimate the present value of the growth

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
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
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

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

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?

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
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
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
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.

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