Essentials of Corporate Finance

Subject: Finance – Recommended textbook for the subject: Ross, Stephen A., Westerfield, Randolph W., Jordan, Bradford D. Essentials of Corporate Finance. (CHAPTERS 8 & 9) – Answer the following es

Assig nm en t:

A nsw er t h ese e ssay q uestio ns: 1. S eth B ullo ck, th e o w ner o f B ullo ck G old M in in g, is e va lu atin g a n ew g old m in e in S outh D ako ta . D an D orit y , th e c o m pa ny’s g eolo gis t, h as ju st fin is h ed h is a naly sis o f th e m in e s it e . H e h as e stim ate d th at th e m in e w ould b e p ro ductiv e fo r e ig ht y e ars , d urin g w hic h th e g old w ould b e c o m ple te ly m in ed. D an h as ta ke n a n e stim ate o f th e gold d eposit s to A lm a G arre tt, th e c o m pa ny’s fin ancia l o ff ic e r. A lm a h as b een a ske d by S eth to p erfo rm a n a naly sis o f th e n ew m in e a nd p re se n t h er r e co m mendatio n on w heth er th e c o m pany s h ould o pen th e n ew m in e. Y ear C ash F lo w 0 -$ 650,0 00,0 00 1 $80,0 00,0 00 2 $121,0 00,0 00 3 $162,0 00,0 00 4 $221,0 00,0 00 5 $210,0 00,0 00 6 $154,0 00,0 00 7 $108,0 00,0 00 8 $86,0 00,0 00 9 -$ 72,0 00,0 00 A lm a h as u se d th e e stim ate s p ro vid ed b y D an to d ete rm in e th e r e ve nues th at c o uld b e e xp ecte d fr o m th e m in e. S he h as a ls o p ro je cte d th e e xp e nse o f o penin g th e m in e a nd th e a nnual o pera tin g e xp e nse s. If th e c o m pa ny o pens th e m in e, it w ill c o st $ 650 m illio n to day, a nd it w ill h ave a c a sh o utflo w o f $ 72 m illio n n in e y e ars fr o m to day in c o sts a sso cia te d w it h c lo sin g th e m in e a nd r e cla im in g th e a re a s u rro undin g it . T he e xp ecte d c a sh flo w s e ach y e a r fr o m th e m in e a re s h o w n in th e ta ble o n th is p age. B ullo ck M in in g h as a 1 2 p e rc e n t r e quir e d r e tu rn o n a ll o f it s g old m in es. 1 . C onstr u ct a s p re adsh eet to c a lc u la te th e p ayb a ck p erio d, in te rn al r a te o f re tu rn , m odif ie d in te rn al r a te o f r e tu rn , a nd n et p re se n t v a lu e o f th e p ro pose d m in e.

2. B ase d o n y o ur a naly sis , s h ou ld th e c o m pa ny o pen th e m in e?

3. B onus q uestio n: M ost s p re adsh e ets d o n ot h ave a b uilt – in fo rm ula to c a lc u la te t h e p ayb ack p erio d. W rit e a V B A s crip t th at c a lc u la te s th e p ayb a ck p erio d fo r a p ro je ct. 2 . M cK eekin C orp . h as a p ro je ct w it h th e fo llo w in g c a sh flo w s: Y ear C ash F lo w 0 $20,0 00 Year C ash F lo w 1 -$ 26,0 00 2 $13,0 00 a. Wh at is th e IR R o f th is p ro je ct?

b . E xp la in w hat is h appenin g h ere . 3. C onch R epublic E le ctr o nic s is a m id siz e d e le ctr o nic s m an ufa ctu re r lo ca te d in K ey W est, F lo rid a. T he c o m pany p re sid ent is S helly C outs , w ho in herit e d th e c o m pany.

T he c o m pany o rig in ally r e pair e d r a dio s a nd o th er h ouse h old a pplia nce s w hen it w as fo unded o ve r 7 0 y e ars a go. O ve r th e y e a rs , th e c o m pa ny h as e xp anded, a nd it is n ow a r e puta ble m anufa ctu re r o f v a rio us s p e cia lt y e le ctr o nic it e m s. T he c o m pany hir e d J a y M cC anle ss, a r e ce nt M BA g ra duate , in it s fin ance d epartm ent. O ne o f th e m ajo r r e ve nue-p ro ducin g it e m s m an ufa ctu re d b y C onch R epublic is a s m art p hone.

C onch R epublic c u rre ntly h as o ne s m art p hone m od el o n th e m ark e t a nd s a le s have b een e xce lle nt. T he s m art p hone is a u niq ue it e m in th at it c o m es in a v a rie ty o f tr o pic a l c o lo rs a nd is p re pro gra m med to p la y J im my B uff e tt m usic . H ow eve r, a s w it h a ny e le ctr o nic it e m , te ch nolo gy c h a nges r a pid ly , a nd th e c u rre nt s m art p hone has lim it e d fe atu re s in c o m paris o n w it h n ew er m od els .

C onch R epublic s p ent $ 750,0 00 to d eve lo p a p ro to ty p e fo r a n ew s m art p hone th at has a ll th e fe atu re s o f th e e xis tin g o ne b ut a dds n ew fe atu re s s u ch a s w if i te th erin g.

T he c o m pany h as s p ent a fu rth e r $ 200,0 00 fo r a m ark e tin g s tu dy to d ete rm in e th e exp ecte d s a le s fig ure s fo r th e n e w s m art p hone. C onch R epublic c a n m anufa ctu re th e n ew s m art p hone fo r $ 205 e ach in v a ria ble c o sts . F ix e d c o sts fo r th e o pera tio n are e stim ate d to r u n $ 5.1 m illio n p er y e a r. T he e stim ate d s a le s v o lu m e is 6 4,0 00, 106,0 00, 8 7,0 00, 7 8,0 00, a nd 5 4,0 00 p er y e a r fo r th e n ext fiv e y e ars , r e sp ectiv e ly .

T he u nit p ric e o f th e n ew s m art p hone w ill b e $ 485. T he n ece ssa ry e quip m ent c a n be p urc h ase d fo r $ 34.5 m illio n a nd w ill b e d epre cia te d o n a s e ve n-y e ar M AC RS sch edule . It is b elie ve d th e v a lu e o f th e e quip m en t in fiv e y e a rs w ill b e $ 5.5 m illio n.

N et w ork in g c a pit a l fo r th e s m art p hones w ill b e 2 0 p erc e n t o f s a le s a nd w ill o ccu r w it h th e tim in g o f th e c a sh flo w s fo r th e y e a r ( i. e ., th ere is n o in it ia l o ut- la y fo r N W C).

C hanges in N WC w ill th us fir s t o ccu r in Y ea r 1 w it h th e fir s t y e a r’s s a le s. C onch R epublic h as a 3 5 p erc e nt c o rp ora te ta x r a te a nd a r e quir e d r e tu rn o f 1 2 p erc e nt.

S helly h as a ske d J a y to p re pare a r e port th at a nsw ers th e fo llo w in g q uestio ns: a . Wh at is th e p ayb ack p erio d o f th e p ro je ct?

b . Wh at is th e p ro fit a bilit y in dex o f th e p ro je ct?

c . Wh at is th e IR R o f th e p ro je ct?

d . Wh at is th e N PV o f th e p ro je ct?

e . H ow s e nsit iv e is th e N PV to c h a nges in th e p ric e o f th e n ew s m art p hone?

f. H ow s e nsit iv e is th e N PV to c h anges in th e q uantit y s o ld ? g. Should Conch Republic produce the new smart phone?

h. Suppose Conch Republic loses sales on other models because of the introduction of the new model. How would this affect your analysis?

i. Given the choice, would a firm prefer to use MACRS depreciation or straight- line depreciation? Why? Provide examples to support your case.

4. Project Evaluation. Aguilera Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:

Year Unit Sales 1 $87,500 2 $105,000 3 $119,000 4 $108,000 5 $92,000 Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year Total fixed costs are $1,450,000 per year variable production costs are $230 per unit, and the units are priced at $355 each. The equipment needed to begin production has an installed cost of $24,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 18 percent. Based on these preliminary project estimates, what is the NPV of the project? What is the IRR?

5. NPV Valuation. The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $109,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5.1 percent per year forever. The project requires an initial investment of $1,425,000.