Capital Budgeting

Practice Set Chapters 21 and 25 Name___________________________________

Please type your numerical solutions below. It is highly recommended that you review the assigned worked out homework problems before attempting this assignment. The problems are worked out in excel and will go a long way in illustrating the correct way to complete this assignment. Good luck.

1. Beta Corporation is considering a 3-d printer that can be leased for $12,000 a year for 8 years. The company's marginal tax rate is 29 percent and the yield to maturity on the company's debt is 6.15 percent. Compute the cost to lease if lease payments and associated tax savings are at the
   a. beginning of each year.
   

b. end of each year.

c. the payments are at the beginning of the year and the tax benefits are spread across the year.

1. You want a new automobile for personal use. Neither depreciation nor interest payments will be tax deductible. You can buy the automobile with a $2,000 down payment and a 7.25 percent, sixty-month loan. The monthly payment will be $665. Alternately, you can lease the automobile with; a $4100 NON –refundable deposit, a $1800 refundable security deposit and lease payments of $517 at the beginning of each month for 60 months. Using a 7.25 percent annual required return to evaluate the salvage value, what must the car be worth at the end of 60 months for the purchase to be more attractive than the lease? What is the indifference point?

2. You are evaluating a target company, and this target company generates free cash flows of $2,500,000 a year. This $2,500,000 is free cash flow available to both the debtholders and the stockholders. No growth is expected and the $2,500,000 is considered perpetual in nature. Additionally, you believe the optimal financing for this acquisition is 50 percent debt and 50 percent common equity. You estimate the after-tax cost of debt to be 7.5% and the after-tax cost of equity to be 9.75%. What is your estimate of the value for this target company?

1. Tom Corporation is considering the acquisition of Jerry Corporation. Jerry Corporation has free cash flows to debt and equity holders of $3,750,000. If Tom Corporations acquires Jerry Corporation, Jerry will reduce operating costs by $1,500,000. This will increase free cash flow to $4,900,000. Assume that cash flows occur at year-end and the weighted average cost of capital is 9.8%.

1. What is the value of Jerry Corporation without a merger?

1. What is the value of Jerry Corporation with the merger?

1. (Stock for Stock Merger) Alpha Corporation is considering the acquisition of Zebra Corporation. Each corporation has the following data:

Existing Income Number of Shares

Alpha Corporation $1,680,200,000 90,080,000

Zebra Corporation $702,800,000 50,735,000

Synergistic additional benefits from the combination are $203,600,000.

What minimum exchange ratio is necessary to keep the Zebra shareholders whole in terms of earnings per share?

What is the maximum exchange ratio that Alpha Corporation shareholders would accept in taking over Zebra Corporation and remain whole in terms of earnings per share? (Note you will need to use the formulas in the book to solve this)

1. (Cash for Stock Merger) This problem requires that you integrate the material learned in prior chapters. You have been given the job of evaluating the following merger candidate. You have collected the following cash flow estimates for the acquisition candidate for the proposed merger (in millions):

Estimated cash flows of the target company:

Year 1 2 3 4 5__

Cash flows now for the target 260 130 200 125 250

Additional cash flows (synergy) 140 210 100 225 150

Total cash flows from target (after merger) 400 340 300 350 400

Risk free rate of return 4.5%

Beta of this target acquisition 1.5

Market risk premium 6%

Pre-tax cost of debt 7%

Marginal after-tax rate 33%

Number of shares outstanding for the target company (millions) 14

Current market price per share for the target company $72

Percentage of the acquisition financed with debt 30%

Percentage of the acquisition financed with common equity 70%

What is the after-tax cost of debt for this merger (as we did in chapter 16)?

What is the after-tax cost of common equity for this merger (as we did in chapter 16)?

What is the weighted average cost of capital for this acquisition candidate (as we did in chapter 16)?

Please run a net present value using the WACC calculated above with the total cash flows from the target (given above) to determine the maximum price per share you are willing to pay for this target candidate?

Based on what you calculated and the current market price, would you pursue this candidate?