Chapter 17: Valuation and Capital Budgeting for the Levered Firm
17.1Honda and GM are competing to sell a fleet of 25 cars to Hertz. Hertz fully depreciates all of its rental cars over five years using the straightline method. The firm expects the fleet of 25 cars to generate $100,000 per year in earnings before taxes and depreciation for five years. Hertz is an allequity firm in the 34percent tax bracket. The required return on the firm’s unlevered equity is 10 percent, and the new fleet will not add to the risk of the firm.
a. What is the maximum price that Hertz should be willing to pay for the new fleet of cars if it remains an allequity firm? b. Suppose Hertz purchases the fleet from GM for $325,000, and Hertz is able to issue $200,000 of five year, 8% debt in order to finance the project. All principal will be repaid in one balloon payment at the end of the fifth year. What is the Adjusted Present Value (APV) of the project?
17.1a.The maximum price that Hertz should be willing to pay for the fleet of cars with allequity funding is the price that makes the NPV of the transaction equal to zero.
NPV = Purchase Price + PV[(1 TC )(Earnings Before Taxes and Depreciation)] +
PV(Depreciation Tax Shield)
Therefore, the most that Hertz should be willing to pay for the fleet of cars with allequity funding is $337,095.
b.The adjusted present value (APV) of a project equals the net present value of the project if it were funded completely by equity plus the net present value of any financing side effects. In Hertz’s case, the NPV of financing side effects equals the aftertax present value of the cash...
...Ryan Nguyen
04/13/2013
Dr. Choi
Finance 3300
Exam 3 Short Essay.
Net Presentvalue is the difference between an investment’s market value and its cost. For an example, you invest 100 dollars (Cost) into a lemonade stand but you receive 50 dollars (Market Value) of cash inflow. Another would be you buy a house for 50,000(Cost) But you sell it for 75,000(Market Value). Your net presentvalue An Investment should be accepted if the net presentvalue is positive and it should be rejected if the net presentvalue is negative. Net presentvalue uses the discounted cash flow of valuation, which is the process of valuing an investment by discounting future cash flows. Comparison to another rule, which is called the Internal rate of return, uses the discount rate that makes the NPV of an Investment zero. IRR finds the single rate that summaries the rate of return of a project. We only depend on cash flow of a particular investment not the rates offered elsewhere. For an example, you let your brother burrow 100 dollars but he pays you back 125 dollars. You would ask what is the return on this investment, which is 25% or 1.25 dollars back for every 1 dollar invested. This investment would be only valid if the required return is less than 25% because anything more would fall in negative...
...
Net presentValue, Mergers and acquisitions
Abstract
Main objective of undertaking this to report was learn about NPV presentvalue (NPV) method to make capital budgeting decision(Google NEW Project) and success factors involved in mergers and acquisitions(GoogleGroupon Case).
Answers to the Assignments
Part I: Google should go ahead with the new project.
PartII: Google’s acquisition of Groupon would have been win win situation for both corporations
Now I will discuss both parts in detail below.
Part I: Capital Budgeting
Capital budgeting is the process of making longterm planning decision relating to planning for capital assets as to whether or not money should be invested in the long term projects (en.wikipedia.com). Decisions like obtaining new facilities or purchase or new machinery to expand their business. It involves a financial analysis of the various alternative proposals regarding a capital expenditure and to select the best out of the several alternatives.
There are several methods of evaluating investment projects like NPV, IRR, Payback period and Profitability Index (www.investopedia.com). I will be discussing NPV and IRR for this assignment.
Net PresentValue (NPV)
NPV is a method which uses discounted cash flow techniques. Net PresentValue is equal to the difference between the Present...
...
Workshop 5 – Capital Budgeting II
1. Basic Concepts Review
a) In applying Net PresentValue, what factors do we include, and what factors do we ignore?
Use cash flows not accounting income
Ignore
* sunk costs
* financing costs
Include
* opportunity costs
* side effects
* working capital
* taxation
* inflation
2. Practice Questions
a) After spending $3 million on research, Better Mousetraps has developed a new trap. The project requires an initial investment in plant and equipment of $6 million. This investment will be depreciated straightline over five years to a value of zero, but, when the project comes to an end in five years, the equipment can in fact be sold for $500,000. The firm believes that working capital at each date must be maintained at 10% of next year's forecasted sales. Production costs are estimated at $1.50 per trap and the traps will be sold for $4 each. (There are no marketing expenses.) Sales forecasts are given in the following table. The firm pays tax at 35% and the required return on the project is 12%. What is the NPV?

Figures in 000's  
Year  0  1  2  3  4  5 
Unit Sales   500  600  1,000  1,000  600 
Revenues   2,000  2,400  4,000  4,000  2,400 
Costs   750  900  1,500  1,500  900 
Depreciation   1,200  1,200  1,200  1,200 ...
...interest charged is 6.8% compounded monthly. Find the monthly payment.
Solution:
Cash price = RM204 600 n = 360
Down payment = 10% × 204 600
= RM20 460
Presentvalue = 204 600 – 20 460
= 184 140
Interest rate per interest period = 6.8%12
= 0.00567
Presentvalue
A = R [1(1+i)n i]
184 140 = R [11+0.005673600.00567]
184 140 = R [11.005673600.00567]
184 140 = R [10.130620.00567]
184 140 = R[0.8693763480.00567]
153.33R = 184 140
R = 184 140153.33
= RM1200.94
Task 4
i. How to Calculate a Discount on a promissory Note. Explain with example.
A promissory is a written promise made by one person or party to repay a loan or debt on a specified future dare to another person or party. That is two types of promissory notes, interest bearing notes and noninterest bearing notes.
Bank discount:
D = sdt
Where, D = Bank discount
S = Amount of maturity value
d = discount rate
t = time in years
Bank proceeds = Maturity value – Bank discount
P = S – D or P = S(1dt)
Example 1:
Sally borrows RM800 for three months from...
...debts. A sole
proprietor has unlimited liability. Investors in corporations have limited liability. They can lose their investment, but no more.
Chapter 2
How to calculate Presentvalues
Question 6: Perpetuities
An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
Answer
NPV = −1,548 + 138/.09 = −14.67 (cost today plus the presentvalue of the
perpetuity).
Question 7: Growing perpetuities
A common stock will pay a cash dividend of $4 next year. After that, the dividends are expected to increase indefinitely at 4% per year. If the discount rate is 14%, what is the PV of the stream of dividend payments?
Answer
PV = 4/(.14 − .04) = $40.
Question 19: Presentvalues
As winner of a breakfast cereal competition, you can choose one of the following prizes:
a. $100,000 now
b. $180,000 at the end of five years
c. $11,400 a year forever
d. $19,000 for each of 10 years
e. $6,500 next year and increasing thereafter by 5% a year forever.
If the interest rate is 12%, which is the most valuable prize?
Answer
a. PV = $100,000.
b. PV = $180,000/1.125 = $102,136.83.
c. PV = $11,400/0.12 = $95,000.
d.
e. PV = $6,500/(0.12 0.05) = $92,857.14.
Prize (d) is the most valuable because it has the highest presentvalue.
Question 20: Annuities
Siefried Basset is 65...
...Examples Of Net PresentValue (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
Net PresentValue  Method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
Discount Rate  Also known as the hurdle rate or required rate of return, is the rate that a project must achieve in order to be accepted rather than rejected.
Return on Investment – Expected income divided by the amount originally invested
Payback Analysis – The number of years needed to recover the initial cash outlay.
Formulas
Net PresentValue = (t=1..n A * (1+r)t OR (t=1..n A/ (1+r)t
Where A = Cash flow
r = Required rate of return
t = year of cash flow
n = the nth year
Return On Investment = (Discounted Benefits – Discounted Costs) / Discounted Costs
Payback Period = Years taken to repay initial outlay .
Eg. Project Z Outlay = $ 4000
Yearly cash flows = $2000
Payback period = 2yrs...
...Net presentvalue
In finance, the net presentvalue (NPV) or net present worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the presentvalues (PVs) of the individual cash flows. In case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise longterm projects. Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in presentvalue terms, once financing charges are met.
The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputting a price; the converse process in DCF analysis, taking as input a sequence of cash flows and a price and inferring as output a discount rate (the discount rate which would yield the given price as NPV) is called the yield, and is more widely used in bond trading.
Formula
Each cash inflow/outflow is discounted back to its presentvalue (PV). Then they are summed. Therefore NPV is the sum of all...
.... To find the PVA, we use the equation:
PVA = C({1 – [1/(1 + r)]t } / r )
PVA = $60,000{[1 – (1/1.0825)9 ] / .0825}
PVA = $370,947.84
The presentvalue of the revenue is greater than the cost, so your company can afford the equipment.
7. Here we need to find the FVA. The equation to find the FVA is:
FVA = C{[(1 + r)t – 1] / r}
FVA for 20 years = $3,000[(1.08520 – 1) / .085]
FVA for 20 years = $145,131.04
FVA for 40 years = $3,000[(1.08540 – 1) / .085]
FVA for 40 years = $887,047.61
Notice that doubling the number of periods does not double the FVA.
8. Here we have the FVA, the length of the annuity, and the interest rate. We want to calculate the annuity payment. Using the FVA equation:
FVA = C{[(1 + r)t – 1] / r}
$40,000 = $C[(1.05257 – 1) / .0525]
We can now solve this equation for the annuity payment. Doing so, we get:
C = $40,000 / 8.204106
C = $4,875.55
9. Here we have the PVA, the length of the annuity, and the interest rate. We want to calculate the annuity payment. Using the PVA equation:
PVA = C({1 – [1/(1 + r)]t } / r)
$30,000 = C{[1 – (1/1.09)7 ] / .09}
We can now solve this equation for the annuity payment. Doing so, we get:
C = $30,000 / 5.03295
C = $5,960.72
10. This cash flow is a perpetuity. To find the PV of a perpetuity, we use the equation:
PV = C / r
PV = $20,000 / .08 = $250,000.00
11. Here we need to find the interest rate that...
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