GROUP ASSIGNMENT
CASE 23: DANFORTH & DONNALLEY LAUNDRY PRODUCTS COMPANY
Purpose of Meeting: To make capital budgeting decision with respect to the introduction and production of a new product, a liquid detergent called Blast. Need to consider what types and which cash flows should be included in capital budgeting analysis. D&D was producing and marketing two major product lines: 1. LiftOff: Low –suds, concentrated powder.
2. Wave: Traditional powder detergent.
Questions & Answers:
1. If you were in Steve Gasper’s place, would you argue to include the cost from market testing as a cash outflow? If I’m Steven Gasper’s I would not include the cost from market testing as a cash outflow. The reason is because the cost from market testing was considered as sunk costs. A sunk cost is an outlay that has already occurred, hence by decision under consideration would not been affected by the costs. Since sunk costs are not incremental cost they should not be included in the analysis. In this case initial cost for Blast, $500,000 for test marketing, which was conducted in the Detroit area and completed in the previous June was consider as a sunk cost and it will not affect Danforth & Donnalley Laundry future cash flows regardless of whether or not the new branch is built.
2. What would your opinion be as to how to deal with the question of working capital? Working capital management deals with the management of current assets which are inventories, payroll, and other cash needs and receivables from customers, account receivable, and also procedures financing these assets. In our opinion, have two basic questions involves in working capital policy: (i) What is the appropriate amount of current assets for the firm to carry both in total and for each specific account and (ii) How should current asset be financed. Therefore, the most important element in best buys working capital policy is its inventory management. Refer to the Danforth...
...
FINC5001 Capital Market and Corporate Finance

Workshop 5 – Capital Budgeting II
1. Basic Concepts Review
a) In applying NetPresentValue, 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 ...
...acquired (or committed in progress) to put aside from their expiration. It is reasonable to believe that the relative effect of coverage suspended in the Reserve of cash flow hedge will primarily be in relief to economic account in the following exercise.
The Group is exposed to consequential risks by the variation of the rates of change, that you/they can influence on its economic result and on the value of the clean patrimony. Particularly:
Whereas the societies of the Group sustain costs denominated in different currencies by those of denomination of the respective proceeds, the variation of the rates of change can influence the Result operational of such societies. In 2012, the general amount of the commercial flows directly statements to the risk of change you/he/she has been equivalent to 10% around of the billing. Gives the last budget of Fiat the total billing of 83 billion of euro therefore the figure that we will go to analyze is equal to 830 million of Euro.
CASE STUDY
The Group, which operates in numerous markets worldwide, is naturally exposed to market risks stemming from fluctuations in currency and interest rates. The exposure to currency risk is mainly linked to the difference in geographic location between the Group’s manufacturing activities and its commercial activities, resulting in cash flows from exports denominated in currencies that differ from those associated with production activities. The Group...
...consideration in capital budgeting? a Will an investment generate adequate cash flows to promptly recover its cost? b Will an investment generate an acceptable rate of return? c Will an investment have a positive netpresentvalue? d Will an investment have an adverse effect on the environment? 3 Which of the following is not considered when using the payback period to evaluate an investment? a The profitability of the investment over its entire life. b The annual netcash flow of the investment. c The cost of the investment. d The expected life of the investment. Use the following data for questions 4 and 5. Stone Mfg. is considering expanding operations by investing $300,000 in equipment. The equipment has a useful life of eight years, with no salvage value. Straightline depreciation is used. Stone predicts that net income will increase $37,500 per year as a result of this strategy. 4 Refer to the above data. The payback period for this investment is: a 8 years. b 4 years. c Over 13 years. d 2.5 years. 5 Refer to the above data. Return on average investment for this investment is: a 25%. b 20%. c 12 1/2%. d 15%.
CHAPTER 26 10MINUTE QUIZ B
NAME SECTION
#
Physician’s Pharmacy is considering the purchase of a copying machine which it will make available to customers at a percopy charge. The copying machine has an initial cost of $7,500, an...
...Examples Of NetPresentValue (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
NetPresentValue  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
NetPresentValue = (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...
...investment but low rate investment such as Tbills or bonds.
E) Which of the following is true about the NPV and IRR techniques?
1) The NPV and IRR techniques always provide the same ranking of different investment projects.
2) The NPV and IRR techniques explicitly consider the cost of capital and the time value of money.
3) All projects can have only one value for NPV and one value for IRR.
4) The NPV technique cannot provide information on how acquiring the project will contribute to shareholders’ wealth.
Explanation: NPV calculates presentvalue of investment and opportunity cost of capital and IRR takes time value of money and cost of capital into consideration as well.
F) Which of the following is false?
1) The profitability index method explicitly considers the time value of money and the firm’s cost of capital.
2) The payback period is preferred by managers since it is simple, easy to calculate, and estimates how quickly the project cash flows will return the investment in the project.
3) The disadvantages of the payback period method are that it ignores project cash flows which occur after the payback period as well as the time value of money.
4) The profitability index method always ranks all projects in the same way that the IRR method does.
Explanation: In IRR method projects are accepted if the...
...Capital inv appraisal of new technologies: Problems, misconceptions and research directions
* Specifically, it has been alleged that the traditional appraisal methods of payback,
discounted netpresentvalue (NPV) and internal rate of return (IRR) undervalues the longterm
benefits; that traditional financial appraisals assume a far too static view of future industrial
activity, underrating the effects and pace of technological change; that there are many benefits
from investments in new technology which are difficult to quantify and are often ignored in the
appraisal process; and lastly, it is claimed that the systems of management control often employed
by large organizations compound the bias against those investments which, although expensive,
reap rewards vital for longterm viability. The first issue is a criticism of financial technique; the
next two are criticisms of the way in which business operations are modelled; and the last is an
issue of organizationalc ontrol and behavior.
* We show that the criticisms directeda traditional appraisal methods may to some extent be based on misconceptions of the financial models and the ways in which they are best used
* A similar objection is raised to the use of NPV and IRR. The claim is that discounting future cash benefits underemphasizes the future benefits of new technology. This problem may be exacerbated by the application of risk premia...
...(qualitatively) to value AirThread. Should Ms. Zhang use WACC, APV or some combination thereof? Explain. (2 points)
* From the statement of AirThread case, we know that American Cable Communication want to raise capital by Leveraged Buyout (LBO) approach. This means ACC will finance money though equity and debt to buy AirThread and pay the debt by the cash flows or assets of AirThread.
* In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact.
* If we want to use WACC method, one assumption must be met: this program will not change the debtequity ratio of AirThread. Under LBO approach, it’s impossible.
* So we decide to use APV method to value AirThread. WACC method is not appropriate here, but we still need to calculate the weight average cost of capital (WACC) of AirThread.
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered free cash flow for AirThread.
* Discount AirThread’s unlevered free cash flows at unlevered WACC.
2. Determine the PV of interest tax shield:
* Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend Discount Model (Gordon Growth Model) to estimate...
...Bonds pay semiannual coupons unless otherwise stated;
7) Bonds have a par value (or face value) of $1,000; and
8) You may use the back of the exam paper as your scrap paper.
Good Luck.
32 Calculation Questions (4 marks each)
1. The common stock of Robin's Tools sells for $24.50. The firm's beta is 1.2, the riskfree rate is 4%, and the return on the market portfolio is 12%. Next year's dividend is
expected to be $1.50. Assuming that dividend growth is expected to remain constant
for Robin’s Tools over the foreseeable future, what is the firm's anticipated dividend
growth rate?
A)
B)
C)
D)
E)
6.65%
7.48%
9.15%
13.6%
15.0%
Solution: B
r = 4% + 1.2 x (12%  4%) = 13.6% and
$24.50 = $1.50 / (13.6%  g)
Leads to g = 7.48%
2. What is the yield to maturity on a 10year zerocoupon bond with a $1,000 face value
selling at $742?
A)
B)
C)
D)
E)
3.03%
7.42%
13.48%
34.78
42.37%
Solution: A
YTM = (1000/742) 1/10 1 = .03029 or 3.03%
3. Consider the following monthly cash flows (see the diagram below):
X
Today
Z
X
Z
X
Z
1
2
3
4
19
20
Cash flows of an amount X are made for months 1, 3, 5, …, 17 and 19 (the ten oddnumbered months) and cash flows of an amount Z are made for months 2, 4, 6, …, 18
and 20 (the ten evennumbered months). The APR is 6% and is compounded on a
monthly basis. What is the...
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