I. Estimating the internal rate of return:
A project has an initial outlay (cost) of $3, 817. The project has a three year life.
The estimated cash flows each year are as follows: Year 1: $1,000; Year 2: $2,000; Year 3: $3,000. Using the `annuity equivalent’ estimating technique that we used in class, What is IRR? And will the real internal rate of return on this project be equal to, less than, or greater than answer? SHOW WORK!
Part B. Assuming cost of capital is 12%, what is NPV
Part C. Assuming cost of capital at 27%, what is NPV, should this project be accepted?
II. Cost of Capital:
A firm can raise long term funds at the after-tax costs noted below.
Debt: $ 0 to $300,000 …………… 6 %
Over $300,000 …………… 8 %
Preferred: All it wishes ………….. 17 %
Common: $ 0 to $200,000 ………. 18 %
Over $200,000 ……………22 %
If the firm’s optimal capital structure is 45% Debt, 10% preferred and 45% common equity, what are the break-points in the cost of capital curve? (Hint: there are three of them.) Note the dollar amount and the cost for each of these segments.
B. assuming a firm has nine non-mutually exclusive projects it can invest in. Which of the following projects should be accepted according to the Cost of Capital(WACC) you came up with and what will you charge these projects?
Project IRR Cost
A 15 % $ 300,000
B 14 % 600,000
C 13 % 100,000
D 17 % 100,000
E 19 % 200,000
F 10 % 100,000
G 11 % 200,000
H 12 % 300,000
I 16 % 400,000
III. Capital rationing:
A firm has nine non-mutually exclusive projects it can invest in. The projects, the respective internal rates of return and the project costs are noted below. If the firm can invest in only $1,000,000 of projects, which should it select?
Project IRR Cost
A 15 % $ 300,000
B 14 % 600,000
C 13 % 100,000
D 17 % 100,000
E 19 % 200,000
F 22 % 100,000
G 23 % 200,000
H 21 % 300,000
I 16 % 400,000
IV. Value of a bond
Coupon Rate=5% Term to Maturity=10 years Value=100,000 This is a Semi annual bond
What is the value of the bond if current markets rates are 4.5%, and 6%?
V. Chucks Bottle shop is seeing what the Economic ordering quantity is for Beer to improve inventory control. Anticipated sales for the year are 75,000 units, Ordering cost is $8 per order and carrying cost of $1.2 per unit. (Sorry mistyped the question, it 1.2 not 12)
A. What is EOQ?
B. How many orders will be placed curing the year?
C. What will average inventory be?
D. What is the total cost of ordering and carry inventory?
VI. Chucks bottle can barrow funds at 11%, the terms of cash discount is 2/15, net 60. Should chucks bottle borrow the funds?
Problem I answer Part A 3817/2000=1.9
From table, PVFA=28% Would be less than 28% because money is coming later.
Answer Part B. 4622.59-3817=805.59
Answer Part C No, NPV is negative 325.03 and always considered first
Answer II A. First 444,444=12.5%
Next 222,222=14.3%
Next amount up to infinity=15.2%
Answer B. Choose From highest IRR first, E,D,I. Charge the highest rate of 15.2%
Answer III. In most profitable order G,F,H,E,D,C
Answer IV at 4.5% n=20, r=2.25 CP=2500, TV=100000 Current Value=103990.93
Answer IV at 6% % n=20, r=3 CP=2500, TV=100000 Current Value=92561.26
Answer V A=1000 units B=75 orders C=500 units D=1,200
Answer VI. Effective rate of interest on discount is 16.32%, so cheaper to barrow the money at 11%.