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(Solved) 9-2 LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would


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9-2
LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of
8%. LL believes it could issue new bonds at par that would provide a similar yield to
maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt? Initial Investment Outlay (Capital Expenditure for new equipment) + (Initial investment in
working Capital)
Initial Investment Outlay = $12,000,000+ 5,000,000
Initial Investment Outlay= $17,000,000
Research expense incurred in last year related to this project is a sunk cost. It will not be
considered while evaluating project at current moment. The answer will not change.
In this case sale value of building after tax represents opportunity cost. That means we are
losing opportunity of $ 1.5 million if equipment installed in own building, Hence this will be
considered.
Project Cost= $18,500,000 ( $17,000,000 + $ 1,500,000) 9-5
Summerdahl Resort’s common stock is currently trading at $36 a share. The stock is
expected to pay a dividend of $3.00 a share at the end of the year (D1 = $3.00), and the
dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity? 9-6
Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%, and the yield
on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an
average stock in the market last year was 15%. What is the estimated cost of common
equity using the CAPM? 9-8
David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to
maturity on the company’s outstanding bonds is 9%, and the company’s tax rate is 40%.
Ortiz’s CFO has calculated the company’s WACC as 9.96%. What is the company’s cost of
equity capital? 10-1
A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7
years, and a cost of capital of 11%. What is the project’s NPV? (Hint: Begin by
constructing a time line.)
(10-2) Refer to Problem 10-1. What is the project’s IRR?
(10-3) Refer to Problem 10-1. What is the project’s MIRR?
Refer to Problem 10-1. What is the project’s PI?
(10-5) Refer to Problem 10-1. What is the project’s payback period?
(10-6) Refer to Problem 10-1. What is the project’s discounted payback period? 10-8
Edelman Engineering is considering including two pieces of equipment, a truck and an
overhead pulley system, in this year’s capital budget. The projects are independent. The
cash outlay for the truck is $17,100 and that for the pulley system is $22,430. The firm’s
cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:
Year
1
2
3
4
5 Truck
$5,100
5,100
5,100
5,100
5,100 Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct
accept–reject decision for each Pulley
$7,500
7,500
7,500
7,500
7,500 11-1
Talbot Industries is considering launching a new product. The new manufacturing
equipment will cost $17 million, and production and sales will require an initial $5 million
investment in net operating working capital. The company’s tax rate is 40%.
a. What is the initial investment outlay?
b. The company spent and expensed $150,000 on research related to the new product
last year. Would this change your answer? Explain.
c. Rather than build a new manufacturing facility, the company plans to install the
equipment in a building it owns but is not now using. The building could be sold for
$1.5 million after taxes and real estate commissions. How would this affect your
answer? 11-2
The financial staff of Cairn Communications has identified the following information for
the first year of the roll-out of its new proposed service:
Projected sales $18 million
Operating costs (not including depreciation) $ 9 million
Depreciation $ 4 million
Interest expense $ 3 million
The company faces a 40% tax rate. What is the project’s operating cash flow for the first
year (t = 1)? 11-3
Allen Air Lines must liquidate some equipment that is being replaced. The equipment
originally cost $12 million, of which 75% has been depreciated. The used equipment can
be sold today for $4 million, and its tax rate is 40%. What is the equipment’s after-tax net
salvage value? 11-4
Although the Chen Company’s milling machine is old, it is still in relatively good working
order and would last for another 10 years. It is inefficient compared to modern standards,
though, and so the company is considering replacing it. The new milling machine, at a
cost of $110,000 delivered and installed, would also last for 10 years and would produce
after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It
would have zero salvage value at the end of its life. The firm’s WACC is 10%, and its
marginal tax rate is 35%. Should Chen buy the new machine? 11-6
The Campbell Company is considering adding a robotic paint sprayer to its
production line. The sprayer’s base price is $1,080,000, and it would cost another
$22,500 to install it. The machine falls into the MACRS 3-year class, and it would be
sold after 3 years for $605,000. The MACRS rates for the first three years are 0.3333,
0.4445, and 0.1481. The machine would require an increase in net working capital
(inventory) of $15,500. The sprayer would not change revenues, but it is expected to
save the firm $380,000 per year in before-tax operating costs, mainly labor.
Campbell’s marginal tax rate is 35%.
a. What is the Year 0 net cash flow?
b. What are the net operating cash flows in Years 1, 2, and 3?
c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of
working capital)?
d. If the project’s cost of capital is 12%, should the machine be purchased 23-1
Zhao Automotive issues fixed-rate debt at a rate of 7.00%. Zhao agrees to an interest rate
swap in which it pays LIBOR to Lee Financial and Lee pays 6.8% to Zhao. What is Zhao’s
resulting net payment? 23-2
A Treasury bond futures contract has a settlement price of 89’08.
What is the implied
annual yield? implied annual yield is 89.08

 


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