Capital Budgeting

Capital Budgeting Midterm Problems Portion Chapters 1-8 Name__________________________

PLEASE DO YOUR OWN WORK AND DO NOT SHARE YOUR WORK WITH OTHERS. Please answer all the problems below in the spaces provided --- you can use your notes, book, and Excel – please do not share your work with outside sources or other students -- thanks.

1. If you place $172,000 into a stock investment account today. If this account earns 5% over the next 15 years, how much will you have in the account at the end of 15 years?

1. How long will it take for $1,500,000 to grow to $2,000,000 in an account that earns 4%.

1. You need $2,000,000 in 40 years. If you can earn 7% on your money, how much do you need to invest at the end of each year to accumulate this?

1. You borrow $280,000 for a house at 5.75% per year for 30 years. What will your monthly payment be? $1,307.20

1. You are in your fifties and decide to max-out your annual investment into your Individual Retirement Account and invest $27,000 at the end of each year for the next 7 years. At the end of this investment period, you will have how much if you earn an effective annual return of 5 percent?

1. A credit card company runs an ad quoting a nominal interest rate of 24 percent on charges. What is the effective interest rate if interest is compounded monthly? (Two decimal places)

1. B Corporation has $1000 par value bonds with 12 years left to maturity, a stated annual coupon rate of 7.2 percent (with semi-annual interest payments). What are these bonds worth today if the required market rate of return is 10.2 percent?

1. D Corporation has a bond outstanding with a coupon rate of 5.5 percent (paying annual coupons) and a $1000 par value. The bond has 12 years left to maturity. The bond is selling for $1050. What is the yield to maturity for this bond?

1. G Corporation has an outstanding bond. It has a coupon rate of 6.50 percent (paying annual coupons) and a $1000 par value. The bond has 10 years left to maturity. The bond is selling for $1,010. The current yield (not yield to maturity) on this bond is?

1. Z Corporation has an outstanding bond. It has a coupon rate of 7.2 percent paying annual interest coupons and a $1000 par value. The bond has 8 years left to maturity but could be called after 5 years for $1000 plus a call premium of $45. The bond is selling for $1060. What is the yield to call on this bond?

1. Bill Inc. common stock is expected to pay a $3.64 dividend at the end of the year and is in a risk class that requires a 10.5% required return. If this dividend

is expected to grow forever at a 3.0% rate, what is the estimated value of Bill Inc.’s common stock? _____$48.53__________

1. Joe Inc.’s preferred stock is expected to pay a $18.50 dividend annually and is expected to do this forever. Joe Inc. is in a high-risk business that requires an

9.8% return. What is the estimated value of Joe Inc.’s preferred stock? _______$205.56________

1. You place a commercial building into service on July 31, 2023, costing $84,600,000. What is the depreciation expense allowed by the IRS?

for this building for tax years 2023? _____________And 2024? ______________

1. Joe’s Technology must choose between two repeatable methods of producing a new product. The initial costs and year-end cash benefits are as follows:

Year 0 1 2 3 4 5

Method M -$1,800,000  880,000 950,000 650,000

Method N -$2,800,000 1,200,000 1,450,000 900,000 600,000 300,000

Assume all cash flows occur at year-end and the company’s required return is 4.55 percent.

Please compute the net present value ______________ and the equivalent annuity ________________ for Method M

Please compute the net present value ______________ and the equivalent annuity ________________ for Method N

Which production method should be used? _______________

1. The recently enacted tax law (2018) allows companies to use immediate write of equipment purchases or what they call “bonus” depreciation. This “bonus” depreciation phases out over time and is eliminated by 2025. Assume that we are now in 2025, and the tax law has reverted to the MACRS system discussed in chapter 8 (which is the way the law is written). You place the following equipment into service in the following years with the following tax lives:

Year placed Tax life Cost

Into service

Molds 2025 3 year $196,000

Cars 2026 5 year $235,000

Shelves 2027 7 year $148,000

What is the total depreciation expense allowed by the IRS for all three pieces of equipment for tax years 2027? __________________

1. You are opening your own business and estimate the following expenses and revenues:

Year 1 Year 2 Year 3 Year 4

Revenues $600,000 $1,200,000 $1,800,000 $1,500,000

Cost of goods sold $280,000 $560,000 $ 920,000 $810,000

Accounts payable as a percentage of cost of goods sold…….8.5%

Inventory as a percentage of cost of goods sold……………...7.5%

Cash balance as a percentage of revenues…………….…….4.5%

Accounts receivables as a percentage of revenues…………...5.5%

Accrued expenses as a percentage of revenues…….……….3.5%

All balances are needed in the year prior to the generation of the revenue and expense.

Please calculate the incremental investment in working capital needed for years 0,1,2,3,4. (you do not need to calculate the cash flow from operations – you do not have enough information to do this – only the incremental investment in working capital – all working capital accounts are liquidated at book value at the end of year 4)

Year 0_______________ Year 1_______________ Year 2__________________ Year 3______________ Year 4______________

1. You are opening your own business and estimate the following expenses and revenues:

Revenues year 1 $700,000 growing at 4.5% thereafter.

Cost of goods sold year 1 are 45% of sales each year.

Operating expense year 1 $140,000 growing at 7.5% thereafter.

Taxes all in years 32% per year

Depreciation $16,000 in year 1, $17,000 in year 2, $15,000 in year 3

No working capital is needed -- please predict the after-tax cash flows from operations for the first three years of operations below:

Year 1_______________ Year 2__________________ and Year 3______________

Please use the following information to answer the remaining problems:

Able Corporation has a project with the following cash flows and a 7.25% cost of money: Numbers in parentheses are outflows. Both Year 0 and Year 4 cash flows are outflows.

1. Please calculate the net present value ______________

1. Please calculate the profitability indexes (two decimals please) _________________

1. Please calculate the modified profitability index using the terminal value approach in the textbook (two decimals

please) _______________________

1. Please calculate the internal rate of return (two decimals please) _____________________________

1. Please calculate the modified internal rate of return (two decimals please and per the book) ________________________

1. Please calculate the payback period (two decimals please) ________________________

1. Please calculate the present value payback period (two decimals please) ______________________