Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can be financed at 3 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 14 percent return but would cost 16 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure.
(a) Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the “%” sign in your response.)
(b) Which project(s) should be accepted?
Piece of equipment should be financed.
New machine should be financed.
-United Business Forms’ capital structure is as follows:
Debt 35 %
Preferred stock 30
Common equity 35
The aftertax cost of debt is 10 percent, the cost of preferred stock is 13 percent, and the cost of common equity (in the form of retained earnings) is 16 percent.
Calculate United Business Forms’ weighted cost of each source of capital and the weighted average cost of capital. (Round your answers to 2 decimal places. Omit the “%” sign in your response.)
-Assume a $260,000 investment and the following cash flows for two products:
Year Product X Product Y
1 $ 90,000 $ 80,000
2 80,000 70,000
3 80,000 50,000
4 40,000 80,000
(a) Calculate the payback for products X and Y. (Round your answers to 2 decimal places.)
Which alternative would you select under the payback method?
-Hamilton Control Systems will invest $99,000 in a temporary project that will generate the following cash inflows for the next three years. Use Appendix B.
The firm will also be required to spend $18,000 to close down the project at the end of the three years.
Compute the net present value if the cost of capital is 11 percent. (Round “PV Factor” to 3 decimal places. Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)
Should the investment be undertaken?
-Diaz Camera Company is considering two investments, both of which cost $30,000. The cash flows are as follows:
Use Appendix B.
Year Project A Project B
1 $ 15,000 $ 14,000
2 15,000 14,000
3 6,000 11,000
(a-1) Calculate the payback period for project A and project B. (Round your answers to 2 decimal places.)
Which of the two projects should be chosen based on the payback method?
Calculate the net present value for project A and project B. Assume a cost of capital of 8 percent. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the “$” sign in your response.)
Which of the two projects should be chosen based on the net present value method?
Should a firm normally have more confidence in answer derived based on Net present value method or Payback method?
Net present value method
-King’s Department Store is contemplating the purchase of a new machine at a cost of $28,552. The machine will provide $4,600 per year in cash flow for 11 years. King’s has a cost of capital of 9 percent. Use Appendix D.
(a) What is the internal rate of return? (Round “PV Factor” to 3 decimal places. Round your answer to the nearest whole percent. Omit the “%” sign in your response.)
Should the project be undertaken?
-Wildcat Oil Company was set up to take large risks and is willing to take the greatest risk possible. Richmond Construction Company is more typical of the average corporation and is risk-averse.
Expected value Standard
A $ 320,000 $ 149,000
B 693,000 435,000
C 187,000 152,000
D 145,000 234,000
(a-1) Compute the coefficients of variation. (Round your answers to 3 decimal places.)
Which of the following four projects should Wildcat Oil Company choose?
Which one of the four projects should Richmond Construction Company choose based on the same criteria of using the coefficient of variation?