Scribd
Upload
67 views9 pages

S I - P A Use The Following Information To Respond To The Next Two Items, Below

The document provides financial information for analyzing potential investments by Bootes Inc. and evaluating two projects, J and K. It also provides information to analyze whether Redstone Corporation should purchase or lease manufacturing tools. Key details include estimated cash flows for Bootes, NPV and IRR calculations for projects J and K, lease vs purchase calculations for Redstone, and analysis of spectrometer acquisition for an R&D department.

Uploaded by

JimmyChao
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
67 views9 pages

S I - P A Use The Following Information To Respond To The Next Two Items, Below

The document provides financial information for analyzing potential investments by Bootes Inc. and evaluating two projects, J and K. It also provides information to analyze whether Redstone Corporation should purchase or lease manufacturing tools. Key details include estimated cash flows for Bootes, NPV and IRR calculations for projects J and K, lease vs purchase calculations for Redstone, and analysis of spectrometer acquisition for an R&D department.

Uploaded by

JimmyChao
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 9

SECTION I PROBLEM ANALYSIS

Use the following information to respond to the next two items, below.
Assume today is December 31, 2009. As a financial analyst interested in valuing the common
stock of Bootes, Inc., you have estimated the following end-of-year free cash flows (FCFs) for the
company:
End of
Year
2010
2011
2012
2013

Estimated FCF ($ millions)


$135.0
135.0
185.0
220.0

You estimate that after 2013, the FCF of the firm will grow at a constant 5% per year forever. You
estimate that the weighted average cost of capital for the firm is 14%.
1. What is your estimate of the terminal (horizon) value of the firm? (5 points)

Page 1 of 9

File Name: 325265810

2. What is your estimate of the value of the entire firm in todays dollars? (5 points)

Use the following information to respond to the next four items, below.
You have collected the following information on two mutually exclusive investment proposals:
Estimated After-tax Cash Flows
End of
Year
0
1
2
3

Project J
-$100,000
20,000
45,000
80,000

Project K
-$100,000
45,000
45,000
45,000

You estimate the cost of capital applicable to each project is 12% and have computed the following
measures for Project K:
NPV = $8,082.41
IRR = 16.65%
MIRR = 14.94%
3. Compute the net present value for Project J. (5 points)

Page 2 of 9

File Name: 325265810

4. Compute the internal rate of return for Project J. (5 points)

5. Compute the modified internal rate of return for Project J. (10 points)

6. Given your calculations above, which project (if any) do you prefer? Why? (5 points)

Page 3 of 9

File Name: 325265810

Use the following information to respond to the next five (5) items.
Redstone Corporation is considering a leasing arrangement to finance some special manufacturing
tools that it needs for production during the next three years. A planned change in the firm's production
technology will make the tools obsolete after 3 years. The firm will depreciate the cost of the tools on a
straight-line basis over three years (i.e. depreciation expense is 1/3 of the purchase price at the end of
each year for three years). Thus, the book value and the salvage value at the end of the third year will
be zero. The firm can borrow $4,800,000, the purchase price, at a pre-tax cost of 10 percent to buy the
tools, or it can make three equal beginning-of-year lease payments of $2,100,000 that include
maintenance. The firm's tax rate is 40 percent. Annual maintenance costs associated with purchasing
the equipment are estimated at $240,000 per year and are paid at the beginning of each year.
7.

Compute the after-tax lease payments and enter in the table, below. Note: You do not necessarily
need to use all the cells in the table. (5 points)

Lease Alternative

End of year:
0

8. Compute the present value of the lease alternative. (5 points)

Page 4 of 9

File Name: 325265810

9.

Compute the operating cash flows for years t = 0 through t = 3 and place them in the table, below.
Note: You do not necessarily need to use all the cells in the table. (10 points)

Purchase Alternative

End of year:
0

10. Compute the present value of the purchasing alternative. (5 points)

11. Should Redstone purchase or lease the equipment? To answer this question, compute the net
advantage to leasing (NAL) and interpret the results. (5 points)

Page 5 of 9

File Name: 325265810

12. Jackson Co. has the following balance sheet as of December 31, 2009:
Assets
Current assets
Fixed assets

Liabilities & Equity


$600,000
400,000

Accounts payable
Accruals
Notes payable
Total current liabilities
Long-term debt
Total equity

Total Assets

$1,000,000

Total Liabilities & Equity

$100,000
100,000
100,000
$300,000
300,000
400,000
$1,000,000

In 2009, the company reported sales of $5 million, net income of $100,000, and dividends of $60,000.
The company anticipates its sales will increase 20 percent in 2010 and its dividend payout will remain
at 60 percent. Assume the company is at full capacity, so its assets and spontaneous liabilities will
increase proportionately with the increase in sales.
Assume the company uses the AFN formula and all additional funds needed (AFN) will come from
issuing new long-term debt. Given its forecast, how much long-term debt will the company have to
issue in 2010? (10 points)

Page 6 of 9

File Name: 325265810

Use the following information to respond to the next 3 items, below.


You have been asked by the president of your company to evaluate the proposed acquisition of the
new MLM Model 53 spectrometer for your firms R&D department. The equipments invoice
price is $100,000, and it would cost another $10,000 to modify it for special use by your firm. The
spectrometer, which falls into the MACRS 3-year class, would be sold after 3 years for $12,700.
Use of the equipment would require an increase in net working capital (spare parts inventory) of
$3,000 which is expected to be fully recovered at the end of the project. The spectrometer is
expected to increase revenues by $60,000 per year, but would also increase operating costs by
$20,000 per year. Last year, the firm spent $10,000 to assess the various spectrometers in the
marketplace before deciding that the MLM Model 53 was the best choice among the available
models. The firms marginal federal-plus-state tax rate is 40%.
13. What is the net cost of the spectrometer, i.e. what is the time 0 net cash flow? (5 points)

14. What is the non-operating (terminal) cash flow at the end of year 3? (5 points)

Page 7 of 9

File Name: 325265810

15. What are the net operating cash flows in years 1, 2 and 3? Do not include the termination cash
flows that you computed in the previous item. Note: You do not necessarily need to use all of the
spaces provided below. (10 points)

Item

End of
Year 1

End of
Year 2

End of
Year 3

Net After-Tax Cash Flow

Page 8 of 9

File Name: 325265810

SECTION II SHORT ESSAY QUESTION


16. As the Chief Financial Officer (CFO) for Canes Venatici Company, Inc., one of your staff financial
analysts has presented you with a capital budgeting proposal. He has estimated that the internal
rate of return for the proposed project is 26% and goes on to state, I think we should undertake
the project. After all, a 26% return on our investment is great in the current economic
environment. (Assume that the net present value of the project is positive and the project meets
all other corporate-wide capital budgeting guidelines.) How do you respond to your staff analysts
claim? (5 points)

Page 9 of 9

File Name: 325265810

You might also like