1. (Net present value, profitability index, and internal rate of return calculations) You are considering two independent projects, project A and project B.
The initial cash outlay associated with project A is $50,000 and the initial cash outlay associated with project B is $70,000. The required rate of return on both projects is 12 percent.
The expected annual free cash flows from each project are as follows:
Year Project A Project B
0 -50,000 -70,000
1 12,000 13,000
2 12,000 13,000
3 12,000 13,000
4 12,000 13,000
5 12,000 13,000
6 12,000 13,000
Calculate the NPV, PI, and IRR for each project and indicate if the project should be accepted.
2. (NPV with varying rates of return) Johnson Motors is considering building a new factory to produce aluminum baseball bats. This project would require an
initial cash outlay of $5,000,000 and will generate annual free cash inflows of $1 million per year for eight years. Calculate the project’s NPV given:
1. A required rate of return of 9 percent
2. A required rate of return of 11 percent
3. A required rate of return of 13 percent
4. A required rate of return of 15 percent
3. (NPV with varying required rates of return) Big Steve’s, makers of swizzle sticks, is considering the purchase of a new plastic stamping machine. This investment requires
an initial outlay of $100,000 and will generate free cash inflows of $18,000 per year for 10 years. For each of the listed required rates of return, determine the project’s net present value.
1. The required rate of return is 10 percent. 2. The required rate of return is 15 percent. 3. Would the project be accepted under part (a) or (b)? 4. What is this project’s internal rate of return?
4.(Weighted average cost of capital) The target capital structure for QM Industries is 40 percent common stock, 10 percent preferred stock, and 50 percent debt.
If the cost of equity for the firm is 18 percent, the cost of preferred stock is 10 percent, the before-tax cost of debt is 8 percent, and the firm’s tax rate is 35 percent,
what is QM’s weighted average cost of capital?
5. (Weighted cost of capital) The capital structure for the Bias Corporation follows. The company plans to maintain its debt structure in the future. If the firm has a 6 percent
after-tax cost of debt, a 13.5 percent cost of preferred stock, and a 19 percent cost of common stock, what is the firm’s weighted cost of capital?
Capital structure ($000)
Preferred stock 250
Common stock 3,700
6. The target capital structure for Jowers Manufacturing is 50 percent common stock, 15 percent preferred stock, and 35 percent debt. If the cost of equity for the firm is 20 percent,
the cost of preferred stock is 12 percent, and the before-tax cost of debt is 10 percent, what is Jower’s cost of capital? The firm’s marginal tax rate is 34 percent.