Investment in Assets and required returns
·Cash flow determination
·Non-DCF and DCF techniques
Case: Investment analysis and Lockheed Tri Star
Assignment Questions
1.Compute the payback, net present value (NPV), and internal rate of return (IRR) for this machine. Should Rainbow purchase it? Assume that all cash flows (except the initial purchase) occur at the end of the year, and do not consider taxes. 2.For a $500 per year additional expenditure, Rainbow can get a "Good As New" service contract that essentially keeps the machine in new condition forever. Net of the cost of the service contract, the machine would then produce cash flows of $4,500 per year in perpetuity. Should Rainbow Products purchase the machine with the service contract? 3.Instead of the service contract, Rainbow engineers have devised a different option to preserve and actually enhance the capability of the machine over time. By reinvesting 20% of the annual cost savings back into new machine parts, the engineers can increase the cost savings at a 4% annual rate. For example, at the end of year one, 20% of the $5,000 cost savings ($1,000) is reinvested in the machine; the net cash flow is thus $4,000. Next year, the cash flow from cost savings grows by 4% to $5,200 gross, or $4,160 net, of the 20% reinvestment. As long as the 20% reinvestment continues, the cash flows continue to grow at 4% in perpetuity What should Rainbow Products do? 4.Using the internal rate of return (IRR), which proposal(S) do you recommend? 5.Using the net present value rule (NPV), which proposal(s) do you recommend? 6.How do you explain any difference between the IRR and NPV rankings? Which rule is better? 7.Which of the four subsidy plans would you recommend to the city if the appropriate discount rate is 20%? 8.What is the net Present Value of this project?

9.How many shares of common stock must be issued (at what price) to raise the required capital? 10.What is the effect of this new...

...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...

...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...

...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...

...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...

...
CORPORATEFINANCE CASE STUDY
SUPERMAR VALUATION
Question 1 - Find SUPERMAR’S current firm and equity values under the following capital structure scenarios:
In order to calculate the cash flows the first step is to calculate the necessary inputs for the WACC. The case indicates that the current capital structure is 14% debt. We have all of the other inputs needed to calculate the cost of equity, cost of debt and WACC. The inputs are the following:
Before, calculating the actual firm value, it is important to mention some calculations made for the discounted cash flows. For the net change in working capital we included all of the current assets and liabilities. Cash is included because we saw a direct relationship between the increases in sales each year with the increase in cash, assuming that cash has been used for operational purposes. This increase over years is exactly 3.2%. On the other hand, we identified an odd behavior in the increase of CAPEX. According to accounting principles and using the correct formula of Fixed Assets to calculate the purchases, we identified a CAPEX of €3,125 per year. The formula used to calculate these values is the following:
Ending PPE- Beginning PPE+ Depreciation = CAPEX
However, we took into consideration no net increase (difference between the gross depreciation, which is “0”). This is mainly because as stated in the case, SUPERMAR is not able to invest more cash as the market is...

...considering a major investment programme which will involve the creation of a chain
of retail outlets throughout the United Kingdom. The following cash flows are expected.
Time
Land and Buildings
Fittings and Equipment
Gross Turnover
Direct Costs
Marketing
Office Overheads
0
£000
3,250
700
1
£000
2
£000
3
£000
4
£000
1,800
750
170
125
2,500
1,100
250
125
2,800
1,500
200
125
3,000
1,600
200
125
(a)
60% of office overhead is an allocation of head office operating costs.
(b)
The cost of land and buildings includes £80,000 which has been spent on surveyors fees.
(c)
Avanti plc expects to be able to sell the chain at the end of year 4 for £4,000,000.
Avanti plc is paying corporate tax at 30% and is expected to do so for the foreseeable future. Tax
is paid one year in arrears.
The company will claim capital allowances on fittings and equipment at 25% on a reducing balance
basis. Capital allowances are not available on land and buildings. Estimated resale proceeds of
£100,000 for the fittings and equipment have been included in the total figure of £4,000,000 given
above.
Avanti plc expects the working capital requirements to be 15% of turnover during each of the four
years of the investment programme.
Avantis real cost of capital is 7.7% p.a. Inflation at 4% p.a. has been ignored in the above
information. This inflation will not apply to the resale value of the business which...