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Corporate Finance Week 4 Slide Solutions

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62 views4 pages

Corporate Finance Week 4 Slide Solutions

Uploaded by

Kate B
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Corporate Finance

Week 4
Slide Solutions

Chartered Professional Accountants of Canada, CPA Canada, CPA


are trademarks and/or certification marks of the Chartered Professional Accountants of Canada.
© 2020, Chartered Professional Accountants of Canada. All Rights Reserved.
2020-07-16
Corporate Finance Week 4 — Slide Solutions

WEEK 4 SLIDE SOLUTIONS

Solution to Slides 7 and 8, Capital budgeting: NPV — Exercise 1


Capital budgeting NPV:

1. Initial investments:
Assembly line $(1,850,000)
Installation (150,000)
Warehouse (800,000)
Net working capital (500,000)
Land: $250,000 – [(250,000 – 150,000) × 0.50 × 0.28] (236,000)
$(3,536,000)

2. Salvage (at the end of Year 4):


Assembly line $ 300,000
Warehouse 500,000
Land: $500,000 – [($500,000
– 250,000) × 0.50 × 0.28] 465,000
Net working capital 500,000
$1,765,000
Discounted back to Year 1: ($1,765,000 / 1.124) = 1,121,689

3. Incremental after-tax operating cash flows:


Year 1: (1 – 0.28) × ($80 – $60) × 50,000 = $720,000
Discounted back to Year 1: $720,000 / 1.12 = $642,857

Years 2, 3, and 4: (1 – 0.28) × ($80 – $60) × 80,000 = $1,152,000


Discounted back to Year 1: $1,152,000 annuity payment for three
years at 12% / 1.12 = $2,766,909.62 / 1.12 = $2,470,455

Using the financial calculator: [END]; N = 3, I/Y = 12; FV = 0;


PMT = 1,152,000; CPT PV = 2,766,909.62, which then needs to
be discounted back one year: 2,766,909.92 / 1.12 = $2,470,455

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Corporate Finance Week 4 — Slide Solutions

4. PV CCA tax shield and PV CCA tax shield lost:


Assembly line:
($1,850,000 + $150,000) × 0.20 × 0.28 1.18
PV CCA tax shield: × = $368,750
(0.20 + 0.12) 1.12

$300,000 × 0.20 × 0.28 1


PV CCA tax shield lost: × = (33,365)
(0.20 + 0.12) 1.124

Warehouse:
$800,000 × 0.06 × 0.28 1.18
CCA tax shield: × = 78,667
(0.06+ 0.12) 1.12

$500,000 × 0.06 × 0.28 1


CCA tax shield lost: × = (29,658)
(0.06 + 0.12) 1.124

NPV of the project $1,083,395

Gildas should proceed with manufacturing the new toy bear.

Solution to Slides 15 and 16, Lease-versus-purchase decision — Exercise 2


Discount rate (the after-tax cost of debt) = (1 – 0.35) × 0.08 = 0.052

Initial investment outlay (the purchase) = $500,000

Present value of lease payments: (1 – 0.35) × 55,000 × PVAF (5.2%, 6) × 1.052 =


$189,677

Or using the financial calculator:


[BGN]; N=6, I/Y = 5.2; PMT = $35,750; FV = 0, CPT PV = 189,677
500,000 × 0.20 × 0.35 1.078
PV CCA tax shield: × = $142,322
(0.20 + 0.052) 1.052

75,000 × 0.20 × 0.35 1


PV CCA tax shield lost: × = $15,370
(0.20 + 0.052) (1.052)6

Present value of forgone salvage: 75,000 ÷ (1.052)6 = $55,331

NVL = $500,000 – (189,677 + 142,322 – 15,370 + 55,331) = $128,040

Because the NVL is positive, AA should lease the equipment.

Using an alternative method:


NVL = Cost to purchase – Cost to lease

= Cost to purchase : ($500,000)


PVCCA tax shield 142,322

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Corporate Finance Week 4 — Slide Solutions

PVCCA tax shield lost (15,370)


Salvage 55,331
Cost to purchase ($317,717)

Cost to lease: $189,677

NVL = $317,717 – $189,677 = $128.040

Solution to Slide 21, Capital budgeting: Capital rationing — Exercise 3

Total initial
Combination outlay Total NPV
of projects (in millions) (in millions)
1+2+4 $45 $ 54.1
1+3+4 45 57.1
1+2+3+4 60 76.1
1+2+5 55 89.3
1+3+5 55 92.3
1+4+5 60 95.3
2+3+5 60 101.2

Based on the above analysis, OBC Ltd. should invest in projects 2, 3, and 5. Together,
the three projects cost $60 million, which is within the budget constraints, and the NPV
of the combination is $101.2 million, which is higher than any other combination.

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