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BUSI 2505 WINTER 2013 ASSIGNMENT

BUSI 2505 WINTER 2013

ASSIGNMENT # 1

Due Thursday February 14, 2013 (at the beginning of the class)

Problem # 1:

Aussel Motors, Inc.

2006 Income Statement

($ in millions)

Net sales

$6,080

Less: Cost of goods sold

3,890

Less: Depreciation

860

Earnings before interest and taxes

1,330

Less Interest paid

270

Taxable Income

$1,060

Less: Taxes

360

Net Income

$700

Aussell, Inc.

2005 and 2006 Balance Sheets

($ in millions)

2005

2006

2005

2006

Cash

$415

$560

Accounts payable

$540

$610

Accounts receivable

860

840

Current portion LTD

0

50

Inventory

1,270

1,390

Total

540

660

Total

2,545

2,790

Long term debt

2,165

3,480

Net Fixed Assets

3,180

4,660

Common stock

2,000

2,250

Retained earnings

1,020

1,060

Total assets

$5,725

$7,450

Total liab. & equity

$5,720

$7,450

What is the change in the net working capital from 2005 to 2006?

What is the amount of the noncash expenses for 2006?

What is the amount of the net capital spending for 2006?

What is the operating cash flow for 2006?

What is the cash flow from assets for 2006?

What is the amount of net new borrowing for 2006?

What is the cash flow to creditors for 2006?

What is the amount of dividends paid in 2006?

What is the cash flow to stockholders for 2006?

Problem # 2:

You own a rental building in the city and are interested in replacing the heating system. You are faced with the following alternatives:

A solar heating system, which will cost $12,000 to install and $500 a year to run and will last forever (assume that your building does)

A gas heating system, which will cost $5,000 to install and $1,000 a year to run and will last 20 years

An oil heating system, which will cost $3,500 to install and $1,200 a year to run and will last 15 years.

If your discount rate is 10%, which of these three options is best for you?

Problem # 3:

You are helping a bookstore decide whether it should open a coffee shop on the premises. The details of the investment are as follows:

– The coffee shop will cost $50,000 to open; it will have a 5-year life and be depreciated straight-line over the period to a salvage value of $10,000.

– The sales at the shop are expected to be $15,000 in the first year and grow 5% a year for the following four years.

– The operating expenses will be 50% of revenues.

– The tax rate is 40% and expected return is 12%.

– The coffee shop is expected to generate additional sales of $20,000 next year for the book shop, and the pretax operating margin is 40%. These sales will grow 10% a year for the following four years.

Estimate the NPV of the coffee shop without the additional book sales

Estimate the present value of the cash flows accruing from the additional book sales

Would you open the coffee shop?

Problem # 4:

A three –year project will cost $60,000 to construct. This will be depreciated straight-line to zero over the three-year life. The price per unit sold is $20 and the variable cost per unit sold is $10. Fixed costs are $30,000 per year.

If you expect to sell 7000 units per year, what is the OCF in year 2 assuming a required return of 15% and a tax rate of 30%

You now find that a salvage company will pay you $10,000 for the assets at the end of year 3. The project will require an investment of $10,000 up front for net working capital. If you expect to sell 7000 units per year, compute the NPV. Assume a required return of 15% and a tax rate of 30%.

Disregard information in b. You now expect the number of units sold to be 7000 with an upper bound of 8000 and a lower bound of 6000 and you expect the variable cost per unit to be $10 per unit with an upper bound of $12.50 and a lower bound of $7.50. Assuming a tax rate of 30%, compute the IRR for the best case. Assume that salvage is $0 and NWC is $0. Compute the cash break-even point. Compute DOL if quantity sold is 7000 (ignore taxes).

Problem # 5:

The managers of PonchoParts, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next five years. The necessary foundry and machining equipment will cost a total of $800,000 and belongs in a 30% CCA class for tax purposes. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labour and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.

What is the depreciation tax shield in the third year for this project?
What is the present value of the CCA tax shield?

What is the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation?

Assume that management believes that auto restorers will pay $3,000 retail per engine block. What is the NPV of this project?

Problem # 6:

Surgico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions):

Assets

Liabilities

Fixed Assets

$4,000

Debt

$2,500

Current Assets

$1,000

Equity

$2,500

In addition, you are provided the following information:

– The debt is in the form of long-term bonds, with a coupon rate of 10%. The bonds are currently rated AA and are selling at a yield of 12%. The market value of the bonds is 80% of the face value.

– The firm currently has 50 million shares outstanding, and the current market price is $80 per share.

– The stock currently has a beta of 1.2. The Treasury bond rate is 8% and the market risk premium is 5.5%. The tax rate for this firm is 40%

What is the debt-equity ratio for the firm in book value terms? In market value terms?

What is the firm’s cost of equity?

What is the firm’s after-tax cost of capital?

Problem # 7:

Magellen Industries is analyzing a new project. The data they have gathered to date is as follows:

Lower Bound

Expected Value

Upper Bound

Sales quantity

9500

10000

10500

Sales price per unit

$9.75

$10.00

$10.25

Variable cost per unit

$4.80

$5.20

$5.60

Fixed cost

$15,000.00

$18,000.00

$21,000.00

Initial requirement for equipment: $120,000

Depreciation: Straight-line to zero over the four-year life of the project with no salvage value. Required rate of return: 15%

Marginal tax rate: 35%

a. What is the operating cash flow under the base-case scenario?

b. What is the net income under the worst-case scenario?

c. What is the net present value under the best-case scenario?

d. What is the degree of operating leverage under the worst-case scenario?

e. What is the sensitivity of the net present value to a $1 increase in the fixed cost?

f. What is the sensitivity of the net present value to a $1 decrease in the variable cost per unit?

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