FIN440 Capital Budgeting Case - Barrister Industries

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Capital Budgeting Case - Barrister Industries

You are the division finance manager for Barrister Industries, a publicly traded manufacturing company. The division head comes to you very excited, because he just met with a new customer that wants Barrister to be the sole source manufacturer of a key component for one of its current, well selling products. The division head asks you to prepare a financial analysis of whether Barrister should pursue this opportunity.

You discuss the situation with the sales manager and learn that the customer intends to purchase the part from Barrister for the next five years, and will agree to a firm contract for the first three years.

Final Exam Part 1 and Part 2

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Include your calculations for Part 1 on the Excel spreadsheet that you create for Part 2, as these calculations can be worth more points.

Part 2 – Short Answer – Calculations – create your own Excel file (this file may be used for showing your calculations in Part 1 as well)

PART 1:

Multiple choices. 20 questions; 20 points – 1 point each – Select the best answer. In some instances (i.e., a series of calculations), partial credit is possible – but you must give your instructor insight into your thought process via Excel, Word, etc.

Note that you may not get the “exact” answer due to rounding. For that reason, you should round out to at least three digits, and then choose the answer that is closest.

1. Consider the following equally likely project outcomes:

Profit

X                 Y

Pessimistic prediction                                          $ 0              $500

Expected outcome                                               $ 500           $500

Optimistic prediction                                            $1000          $500

a. Project Y has less uncertainty than Project X.

b. Project X has more variability than Project Y.

c. Since Projects X and Y have the same expected outcomes of $500, investors will view them as identical in value.

d. Answers (a) and (b) above are true

Principle of Finance II 1-10 Questions

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1.  A firm has a $40 million capital budget limit. Five high IRR projects of about equal size are available that have initial investments totaling $30M. A sixth project has an IRR slightly lower than those of the first five, but requires a $16M investment. Several smaller projects are available with much lower IRR's. Discuss which projects should be done using capital rationing thinking.

2.  When retained earnings are exhausted, the MCC breaks upward. What happens if the firm continues to raise capital after that? Does the MCC remain flat or move further upward? In either case, why?

3.  Describe the difference between fixed and floating exchange rate systems.

Financial Management: Principles and Application - Caledonia, etc

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Prepare a response to the Caledonia Products Integrative Problem located near the end of Ch. 10 in Financial Management: Principles and Applications.

Formulate answers to questions 11a-11d, 12a–12e and 13a-13d

11. Caledonia is considering two investments with one-year lives. The more expensive of the two

is the better and will produce more savings. Assume these projects are mutually exclusive and that the required rate of return is 10 percent. Given the following after-tax net cash flows:

YEAR PROJECT A PROJECT B

0 −$195,000 −$1,200,000

1 240,000 1,650,000

a. Calculate the net present value.

b. Calculate the profitability index.

c. Calculate the internal rate of return.

d. If there is no capital-rationing constraint, which project should be selected? If there is a capital-rationing constraint, how should the decision be made?

12. Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows:

YEAR PROJECT A PROJECT B

0 −$100,000 −$100,000

1 32,000 0

2 32,000 0

3 32,000 0

4 32,000 0

5 32,000 $200,000

The required rate of return on these projects is 11 percent.

a. What is each project’s payback period?

b. What is each project’s net present value?

c. What is each project’s internal rate of return?

d. What has caused the ranking conflict?

e. Which project should be accepted? Why?

13. The final two mutually exclusive projects that Caledonia is considering involve mutually exclusive pieces of machinery that perform the same task. The two alternatives available provide the following set of after-tax net cash flows:

YEAR EQUIPMENT A EQUIPMENT B

0 −$100,000 −$100,000

1 65,000 32,500

2 65,000 32,500

3 65,000 32,500

4 32,500

5 32,500

6 32,500

7 32,500

8 32,500

9 32,500

Equipment A has an expected life of three years, whereas equipment B has an expected life of

nine years. Assume a required rate of return of 14 percent.

a. Calculate each project’s payback period.

b. Calculate each project’s net present value.

c. Calculate each project’s internal rate of return.

d. Are these projects comparable?

e. Compare these projects using replacement chains and EAAs. Which project should be selected? Support your recommendation.

Superior Manufacturing - Net Present Value Analysis

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Superior Manufacturing is thinking of launching a new product.  The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter.  Direct costs including labor and materials will be 55% of sales.  Indirect incremental costs are estimated at $80,000 a year.  The project requires a new plant that will cost a total of $1,000,000, which will be depreciated straight line over the next five years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000.  Assume there is no need for additional investment in building and land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%.   Based on this information you are to complete the following tasks. 

Prepare a statement showing the incremental cash flows for this project over an 8-year period. If the project required additional investment in land and building, how would this affect your decision? Explain. 

 

Valuation of a Venture - Present Value

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Assignment 3: Valuation of a Venture

Company A has decided to invest in Company B. Company A needs to decide what percent of equity ownership in Company B it will need in exchange for a $10 million investment. Company A has an 18% target compound rate of return for its venture investments. It believes that there’s a 45% chance that the venture will be a total failure, a 40% chance of average performance, and a 15% chance of a very successful venture. Here’s the projected 5-year cash flow stream for the Company B investment that Company A anticipates will occur.

Outcome	Year 1	Year 2	Year 3	Year 4	Year 5
Total Failure	0	0	0	0	$ 0
Average	0	0	0	0	$40 million
Very Successful	0	0	0	0	$115 million

Three Valuation Methods

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1. A firm has the opportunity to do a one-shot project. It requires a date 0 initial outlay for new investment of $250,000. During the initial five-years, it will generate the following before-tax cash flows: date 1 = $380,000, date 2 = $430,000, date 3 = $520,000, date 4 = $460,000, date 5 = $280,000, and $120,000 each year thereafter. The project’s tax rate is 36.0%, its unlevered cost of capital is 11.6%, and the riskfree rate (= cost of debt) is 3.7%. The company has precommitted to a particular quantity of debt on the following dates to support this project: date 0 = $130,000, date 1 = $220,000, date 2 = $270,000, date 3 = $240,000, date 4 = $150,000, and $70,000 each year thereafter. What is the project’s NPV 

Cost Reducing Project

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1. Suppose a firm is considering a labor-saving investment. In year 0, the project requires a $11,700 investment in equipment (all figures are in thousands of dollars). This investment is depreciated using the straight-line method over five years and there is salvage value in year 5 of $4,500. With or without the cost-reducing investment, all cash flows start in year 1 and end in year 5. The inflation rate is 2.6% in year 2 and declines to 1.4% in year 5. The real growth rate is 21.3% in year 2 and declines to 9.5% in year 5. The tax rate is 41.0% in all years. The real cost of capital is 8.7% in year 1 and declines to 7.5% in year 5. Without the cost-reducing investment, the firm's existing investments will generate year 1 revenue, labor costs,

Project Net Present Value

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Note: Tutorial is only for Question 2. Tutorial for Question 1 can be downloaded here.

1. Suppose a firm is considering the following project, where all of the dollar figures are in thousands of dollars. In year 0, the project requires $37,500 investment in plant and equipment, is depreciated using the straight-line method over seven years, and there is a salvage value of $5,600 in year 7. The project is forecast to generate sales of 5,700 units in year 1, rising to 24,100 units in year 5, declining to 8,200 units in year 7, and dropping to zero in year 8. The inflation rate is forecast to be 1.5% in year 1, rising to 2.8% in year 5, and then leveling off. The real cost of capital is forecast to be 9.3% in year 1, rising to 10.6% in year 7. The tax rate is forecast to be a constant 42.0%. Sales revenue per unit is forecast to be $15.30 in year 1 and then grow with inflation. Variable cost per unit is forecast to be $9.20 in year 1 and then grow with inflation. Cash fixed costs are forecast to be $7,940 in year 1 and then grow with inflation. What is the project NPV?

2. Consider the same project as problem 1, but modify it as follows. Suppose that Direct Labor, Materials, Selling Expenses, and Other Variable Costs are forecast to be $5.20, $3.70, $2.30, and $0.80, respectively, in year 1 and then grow with inflation. Lease Payment, 

Project Net Present Value

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1. Suppose a firm is considering the following project, where all of the dollar figures are in thousands of dollars. In year 0, the project requires $37,500 investment in plant and equipment, is depreciated using the straight-line method over seven years, and there is a salvage value of $5,600 in year 7. The project is forecast to generate sales of 5,700 units in year 1, rising to 24,100 units in year 5, declining to 8,200 units in year 7, and dropping to zero in year 8. The inflation rate is forecast to be 1.5% in year 1, rising to 2.8% in year 5, and then leveling off. The real cost of capital is forecast to be 9.3% in year 1, rising to 10.6% in year 7. The tax rate is forecast to be a constant 42.0%. Sales revenue per unit is forecast to be $15.30 in year 1 and then grow with inflation. Variable cost per unit is forecast to be $9.20 in year 1 and then grow with inflation. Cash fixed costs are forecast to be $7,940 in year 1 and then grow with inflation. What is the project NPV? 

Cash budget and Interest

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(Cash budget) The Carmel Corporation’s projected sales for the first eight months of 2004 are as follows:

January $100,000

February 110,000

March 130,000

April 250,000

May $275,000

June 250,000

July 235,000

August 160,000

Of Carmel’s sales, 20 percent is for cash, another 60 percent is collected in the month following sale, and 20 percent is collected in the second month following sale. November and December sales for 2003 were $220,000 and $175,000, respectively. Carmel purchases its raw materials two months in advance of its sales equal to 70 percent of their final sales price. The supplier is paid one month after it makes delivery. For example, purchases for April sales are made in February and payment is made in March. In addition, Carmel pays $10,000 per month for rent and $20,000 each month for other expenditures. Tax prepayments for $23,000 are made each quarter beginning in March. The company’s cash balance at December 31, 2003, was $22,000; a minimum balance of $20,000 must

Net present Value - Amisha

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In the current year ( year 0), Amisha became a shareholder in Sultan Inc., a calender year S corporation, by contributing $15,000 cash om exchange for stock. Shortly before the end of the year, Sultan's CFO notified Amisha that her pro rata share of ordinary loss for the year would be 55,000. Amisha immediately loaned $40,000 to Sultan in exchange for a two-year, interest-bearing corporate note. Consequently, she had enough stock and debt basis to allow her to deduct the $55,000 loss on her current year return. 

Compute the NPV of Amish's cash flow associated with her loan in the following three cases. In each case, assume she has a 35 percent marginal tax rate on ordinary income, a 15 percent on capital gains, and uses a 6 percent discount rate. 

a. For the next two years (year 1 and 2), Amisha share of Sultans ordinary income totaled $49,000, and sultan did not distrubute any cash to its shareholders. However, it did repay the $40,000 loan plus $3,800 interest in year 2.