Problem 1

Year CF (Chinese) CF (Korean) Diff.

0 (420,000) (320,000) (100,000)
1 55,000 80,000 (25,000)
2 75,000 95,000 (20,000)
3 95,000 90,000 5,000
4 140,000 110,000 30,000
5 180,000 120,000 60,000
6 225,000 130,000 95,000
7 260,000 140,000 120,000

a) IRR 21.35% 24.85% (Ans)

b) Crossover 14.94% (Ans)

c) If cost of capital is 16%

CF (Chinese) CF (Korean)

then NPV 91,379.77 98,004.39

We will select Korean Machine with high NPV (Ans)

e) Why Prefer NPV to IRR

Answer given in form

Problem 2

Financial Rate 18%

Project
Year Project Inflow Net Flow
Outflow
0 (88,000) (88,000)
1 40,000 40,000
2 42,000 42,000
3 44,000 44,000
4 46,000 46,000
5 48,000 48,000
6 50,000 50,000
7 52,000 52,000
8 76,000 76,000

a) IRR 47.73%
b) MIRR 29.97%
c) NPV at 18% 102,614
d) Sonnitron should bid the project as MIRR is greater than cost of capital, because the higher MIRR from
cause the higher MIRR from discount rate is better in rank
 Problem 3

Year CF CE Equivalent CE Cash Flow

0 (220,000) 1 (220,000)
1 40,000 0.9 36,000
2 55,000 0.9 49,500
3 72,000 0.8 57,600
4 85,000 0.8 68,000
5 95,000 0.7 66,500
6 100,000 0.6 60,000
a) CE NPV 11,061.04 (Ans)

b) We will accept the project because the the project creates wealth
after fully compensating for risk.
 Problem 4

We Weight of equity 60%

Wd Weight of debt 40%

Kd Shareholder 15%
Ke Bond Holder 12%

t Tax Rate 40%

Answers
a) Cost of retained earning Ke 12.00% (Ans)

b) WACC Wd*kd*(1-tx) + We*Ke 10.80 (Ans)

Problem 5

Given

Cost 720,000
Shipping & Installation 100,000
Modification 52,000

BV of Old Machine 175,000

SV of Old Machine 200,000

Investment Required 100,000

Tax Rate 40%

So Depreciable Basis
Cost + Installation + Modification 872,000

Less Net Salvage Value (Old machine, year 0)

SV - Tx*(SV-BV)
200000-.4*(200000-175000) 190,000

Initial Outlay 782,000 (Ans)

 Problem 6

Projects L M
NPV 8,805.63 10,278.84
Project Life (Years) 6 9
Rate 20%

a) Equivalent Annual Annuity EAA

Given NPV 8,805.63 10,278.84
PVIFA 3.3255 4.0310
EAA 2,647.90 2,549.97

b) As the projects do not have equal life so we will use EAA for our decision rule,
So Project "L" should be selected, because it has indefinite renewal life & Higher EAA
Problem 7

Project Name IRR Risk Group Required Return Decision Reason

M 12.40% Lowest 12.00% Accept RR<IRR
N 22.80% Above Average 21.00% Accept RR<IRR
P 25.90% Highest 24.00% Accept RR<IRR
Q 14.97% Below Average 15.00% Reject RR>IRR
R 17.90% Average 18.00% Reject RR>IRR
S 12.80% Lowest 12.00% Accept RR<IRR

Lowest Below Average Average Above Average Highest

12% 15% 18% 21% 24%
Problem 9 Briefly explain the theoretical reasons why a company does not use the highest possible leverage.

A company needs financial capital to operate its business. For most companies,
financial capital is raised by issuing debt securities and by selling common stock.
The amount of debt and equity that makes up a company’s capital structure has many risk and return implications.
Therefore, corporate management must use a thorough and prudent process for establishing a company’s target capit
The capital structure is how a firm finances its operations and growth by using different sources of funds.
That is the reason company does not use the highest possible leverage.
possible leverage.

nd return implications.
g a company’s target capital structure.
ces of funds.
Explain how capital budgeting decisions are made (that is, decision rules adjusted) in mutually exclusive situations if

a)     Project sizes are very different.

Small projects may be approved by departmental managers. More careful analysis and Board of Director

b)     Project lives are different.

The traditional NPV technique may not be the appropriate criterion to select a project from mutually exclu

c) Project risk are different.

Risk considerations political risk, monetary risk, access to cash flows, economic stability, and inflation sho
ually exclusive situations if

analysis and Board of Directors' approval is needed for large projects of, say, half a million dollars or more.

t a project from mutually exclusive investment projects, if these projects have different lives. The underlying reason is that, compared with a

omic stability, and inflation should all be considered in the evaluation process since all are hidden costs in the  capital budgeting process.
eason is that, compared with a long-life project, a short-life project can be replicated more quickly in the long run. In order to compare proje

e  capital budgeting process.

run. In order to compare projects with different lives, we compute the NPV of an infinite replication of the investment project. 
estment project. 
(a)   A capital intensive operating structure typically has low operating leverage.
(b)   Modified IRR is based on the assumption that project flows are reinvested at the IRR rate.
(c)   Larger projects have a tendency of producing higher IRR values.
(d)   The WACC computation assumes that firms financing decisions are independent of investment dec
(e)   Normal projects typically produce a NPV profile that gently slopes to the right with a slight curve.
1
1
0
1
1
 Problem 12

Depreciable Basis 4,000,000

Description 1 2 3 4
Sales Revenue 8,200,000 8,200,000 8,200,000 8,200,000
Cost of Goods Sold 800,000 800,000 800,000 800,000
Gross Profit 7,400,000 7,400,000 7,400,000 7,400,000
Operating Cash cost 4,510,000 4,510,000 4,510,000 4,510,000
Increase in Before Tax cash flows 2,890,000 2,890,000 2,890,000 2,890,000
Depreciation 2,000,000 1,200,000 800,000 -
CF 2,534,000 2,214,000 2,054,000 1,734,000
Taxable Income 890,000 1,690,000 2,090,000 2,890,000
Tax 40% 356,000 676,000 836,000 1,156,000
Net Income 534,000 1,014,000 1,254,000 1,734,000
Add back Depreciation 2,000,000 1,200,000 800,000 -
Cash Flow=NI+Depreciation 2,534,000 2,214,000 2,054,000 1,734,000
 Year CF Accelerated Depreciation
0 (6,700,000) 50% of Depreciable Basis in year1
1 2,534,000 30% of Depreciable Basis in year2
2 2,214,000 20% of Depreciable Basis in year3
3 2,054,000 Description 1 2
4 1,734,000 Book Value 4,000,000 2,000,000
Depreciation 2,000,000 1,200,000
Ending Book Value 2,000,000 800,000

IRR 11.18%
 3
800,000
800,000
-
Problem 13

Level 1 Level 2 % Change

Volume 400,000 460,000
PPU 45 45
Revenue 18,000,000 20,700,000 15.00%
Variable Cost 45% 8,100,000 9,315,000
Gross Profit 9,900,000 11,385,000
Fixed Cost 600,000 650,000
Depreciation 900,000 900,000
EBIT 9,300,000 10,735,000 15.43%
Interest 650,000 650,000
EBT 7,750,000 9,185,000
Tax 35% 2712500 3214750
Net Income 5,037,500 5,970,250
Number of Shares 750,000 750,000
EPS 6.72 7.96 18.52%
Degree of Operating Leverage 1.03

Degree of Financial Leverage 1.20

Degree of Total Leverage 1.23