Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital is 12 percent, which reflects the project's business risk. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 8 percent and the marginal tax rate is 35 percent. The debt will be paid off in equal annual installments over the project's 10-year life.

A) Calculate APV.

APV = NPV + PV of debt tax shield
NPV = PV of cash flows - initial investment
Initial Investment 10,000,000
Cash flows 1,750,000
Period 10 years
Discounting rate12%
PV of cash flows 9,887,890 using the PV function
NPV (112,110)
We now calculate the PV of debt tax shield

Year Debt Outstanding at Start of Year InterestInterest Tax ShieldsPresent Value of Tax Shields 1 5,000,000 400,000 140,000 129,630
2 4,500,000 360,000 126,000 108,025
3 4,000,000 320,000 112,000 88,909
4 3,500,000 280,000 98,000 72,033
5 3,000,000 240,000 84,000 57,169
6 2,500,000 200,000 70,000 44,112
7 2,000,000 160,000 56,000 32,675
8 1,500,000 120,000 42,000 22,691
9 1,000,000 80,000 28,000 14,007
10 500,000 40,000 14,000 6,485
Total 2,200,000 770,000 575,736

NPV (112,110)
PV of debt tax shield 575,736
APV 463,626

B) How does APV change if the firm incurs issue costs of $400,000 to raise the $5 million of required equity?

...CorporateFinance Exam with Answers
Posted on May 10, 2012 by Sam
CorporateFinance, Chapters 8, 9 & 10. Exam Questions:
1. A project’s opportunity cost of capital is: A. The forgone return from investing in the project.
2. Which of the following statements is correct for a project with a positive NPV? A. The IRR must be greater than 1.
3. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%? C. $16,085
4. The decision rule for net present value is to: C. Accept all projects with positive net present values
5. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%? C. $126,565
6. What is the NPV for the following project cash flows at a discount rate of 15%? [C0= ($1,000), C1= $700, C3= $700.] C. $138
7. Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15%: Project A with three annual cash flows of $1,000; or project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually? A. Project A
8. What is the approximate IRR for a project that costs $100,000 and provides cash inflows of $30,000 for 6 years? A. 19.9%
9. What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years? A. 0.57%...

...of a new machine to produce this product
d. Salvage value of the new machine at the end of its useful life
e. Increase in net working capital at the beginning of the project’s life
f. Cost to develop a product prototype last year
11.2 A division of Blakewell Manufacturing is considering purchasing an auto insert machine to load computer components on mother boards for $1,500,000. The machine will have annual operating costs of $50,000 and save the company $370,000 in labor costs each year. The machine will have a useful life of 10 years. For tax purposes, straight-line depreciation will be used with an estimated salvage value of $300,000 (which will be the market value at that time). The discount rate is 12% and the corporate tax rate is 32%. What is the NPV of this proposal?
11.3 After examining a potential project’s NPV analysis, the manager advises that the initial fixed capital outlay be increased by $480,000. The initial fixed capital outlay is fully depreciated straight-line over a twelve year life. The tax rate is 35 percent and the required rate of return is 10 percent. No other changes are made to the analysis. What is the effect on the project NPV?
11.4 Central Embroidery needs to purchase a new monogram machine and is considering two options. The first machine costs $100,000 and is expected to last 5 years, and the second machine costs $160,000 and is expected to last 8 years. Assume that the opportunity cost of capital is 8...

...Advanced CorporateFinance I SS 2012
Problem Set 1 Valuing Cash Flows
Problem Set 1
Valuing Cash Flows
Exercise 1 (Ex. 11.2 - 11.6 GT): Assume that Marriott’s restaurant division has the following joint distribution with the market return: Market Scenario Bad Good Great .25 .50 .25 Probability Market Return (%) -15 5 25 YR 1. Cash Flow Forecast $40 million $50 million $60 million
Assume also that the CAPM holds. 11.2 Compute the expected year 1 restaurant cash ﬂow for Marriott. 11.3 Find the covariance of the cash ﬂow with the market return and its cash ﬂow beta. 11.4 Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, ﬁnd the certainty equivalent of the year 1 cash ﬂow. What are the advantages and disadvantages of using such historical data for market inputs as opposed to inputs from a set of scenarios, like those given in the table above exercise 11.2? 11.5 Discount your answer in exercise 11.4 at a risk-free rate of 4 percent per year to obtain the present value. 11.6 Explain why the answer to exercise 11.5 diﬀers from the answer in Example 11.2.
1
Advanced CorporateFinance I SS 2012
Problem Set 1 Valuing Cash Flows
Exercise 2 (Ex. 13.1 - 13.7 GT):) Exercises 13.1 - 13.7 make use of the following data: In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation....

...The Net Present Value, Mergers and Acquisitions
Michael D. Black
Trident University
Module 5 CASE
Finance 501: Strategic CorporateFinance
Professor: Walter Witham
June 15, 2012
Net Present Value, Mergers and Acquisitions
Abstract
Financial managers must understand the value of dollars invested today in order to make decisions as to what capital ventures are worth pursuing for business growth. The money a business is willing to invest in new equipment or expansion opportunities must provide positive cash flows. This revenue can be earned through operational income growth or cutting costs resulting in savings. One of the purposes of this paper is to explain the concept of Net Present Value to Micron shareholders so they have an understanding whether to vote in favor or against the company taking on a new project costing $3,219,000. The next topic for analysis is whether a merger between Elpida Memory, Micron Technology and Nanya Technology will benefit shareholders for each company. Lastly, I’ll share what learning objectives I have mastered.
Net Present Value, Mergers and Acquisitions
Financial managers must understand the value of a dollar invested today in order to make decisions as to what capital ventures/projects the company should engage in to expand business operations, earn a profit and increase shareholder wealth. The idea that a dollar today is worth more than a...

...would also have to assume that the bond would be held until its maturity date and all scheduled payments related to the bond would be made on time. AirJet could also use this method to estimate future return on a bond.
d. Explain why you should use the YTM and not the coupon rate as the required return for debt. (5 pts) The coupon rate uses the face value of a bond to compute the bond value. It does not take into consideration the price of the bond at its issue or the redemption value of the bond. As a result, using the coupon rate could cause a large depreciation of funds.
2. Compute the cost of common equity using the CAPM model. For beta, use the average beta of three selected competitors. You may obtain the betas from Yahoo Finance. Assume the risk free rate to be 3% and the market risk premium to be 4%.
Betas from Raytheon (0.75), Lockheed Martin (0.64), and Boeing (1.11) create an average of 0.8333.
a. What is the cost of common equity? (5 pts) Cost of common equity = Risk free rate + (market risk premium * beta) = 3% + (4% * 0.8333) = .03 + .033332 = .063332 = 6.3332%
b. Explain the advantages and disadvantages to use the CAPM model as the method to compute the cost of common equity. Compare and contrast this method with the dividend growth model approach. (10 pts)
CAPM Advantages: it is the most relevant way to determine the risk to stockholders, and it takes into account the systematic risk of the stock that is known as the...

...TOKYO DISNEYLAND AND THE DISNEY SEA PARK: CORPORATE GOVERNANCE AND DIFFERENCES IN THE CAPITAL BUDGETING CONCEPTS AND METHODS BETWEEN AMERICAN AND JAPANESE COMPANIES.
1.What are the industry differences in US Corporate Governance and Japanese Corporate Governance?
JAPANIES CORPORATE GOVERNANCE US CORPORATE GOVERNANCE
Stakeholders of organiztions:
Japanies system believs in the wealth maximization of stake holders, including managers, labour, suppliers, crediters etc American syatem always emphasized on striving for wealth maximization of the share holders and calculated it in terms of CF, capital gains etc
Positive NPV Concept:
Japanies Governance was of the opinion that the motto is not solely wealth maximization of share holder so the capital budgeting criteria was different US governace always check feasibility of the projects in terms of positive NPV
Principle-Agent Relationship
There was no concept of principal agent relationship in Japan, as Japanies believe that even the managers are the principal and can likely to have their own goal setting Unlike Japan, Uscompanies firmly believe in
Principal agent relationship and consider managers to be agents who have to work on the goal setting of share holders
Wealth-Maximization:
Japan believe in long term value maximization US believes in short term value maximization
Status Of Employees:
Empolyees are important stakeholders for Japan The...

...coupon rate could cause a serious depreciation of funds if this method is used
because; the coupon rate uses the face value of the bond, in order to compute the
bond(s) value, and does not take into consideration the price at which the issue of
this bond was or the redemption value of the bond. The Yield to maturity (YTM)
method is better to use because the Yield to maturity (YTM) method incorporates
all fluctuations and the issuing expenses, if any. Thus, the Yield to maturity
(YTM) method is a better method to use, and not the coupon rate as the required
return for debt.
2. Compute the cost of common equity using the CAPM model. For beta, use the average
beta of three selected competitors. You may obtain the betas from Yahoo Finance.
Assume the risk free rate to be 3% and the market risk premium to be 4%.
Risk free Rate 3%
Market risk premium, MRP 4%
Competitors Beta As on October 6, 2010
Dendreon Corp .65 http://finance.yahoo.com/q/ks?s=RTN+Key+Statistics
Douglas Emmet 1.40 http://finance.yahoo.com/q/ks?s=BA+Key+Statistics
Raytheon Company
Common Stock
1.07 http://finance.yahoo.com/q/ks?s=LMT+Key+Statistics
Average Beta 1.04
a. What is the cost of common equity? (5 pts)
The cost of common equity is the annual rate of return that a company, business,
investor, and so on expect to earn when they are investing in shares of a
company.
The cost of common equity is the risk free rate plus (MRP * Beta) = 7.16%
.65 + 1.40 + 1.07= 3.12...

...Capital Budgeting Methods for Corporate Project Selection
In a 2001 Graham and Harvey survey of 392 chief financial officers (CFOs) asked “how frequently they used different capital budgeting methods?” Approximately 75% of the CFOs replied that they use net present value (NPV) or Internal Rate of Return (IRR) always or almost always (Smart, Megginson & Gitman, 2004, pg. 251). Projects are viewed as capital investments in the corporate world, and as such, are evaluated closely for their possible financial impacts on the “bottom line” due to their higher risk of failure. Capital investments are those that are considered long-term investments such as manufacturing plants, R&D, equipment, marketing campaign, etc., and capital budgeting is “the process of identifying which of these investment projects a firm should undertake” (Smart, Megginson & Gitman, 2004, pg. 227). According to Smart, Megginson & Gitman, there are three steps in the capital budgeting process:
* Identifying potential investments
* Analyzing the set of investment opportunities, identifying those that will create shareholder value, and perhaps prioritizing them
* Implementing and Monitoring the investment projects selected
This paper will focus on step two, and will discuss the strengths and weaknesses of the four most common methods that are utilized for evaluating, selecting and prioritizing projects in the corporate world. Net...