Hampton University Complete the Depreciation Line Finance Questions

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Chapter 10 – Integrated Problems from Course Mate (questions a, b (1-3)

Chapter 11 – End of Chapter Concepts (11-1, 11-2, and 11-3)

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CFIN7 - CHAPTER 10 Integrative Problem 10-1 Unilate Textiles is evaluating a new product, a silk/wool blended fabric. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The fabric would be produced in an unused building adjacent to Unilate’s Southern Pines, North Carolina plant. Unilate owns the building, which is fully depreciated. The required equipment would cost $200,000, plus an additional $40,000 for shipping and installation. In addition, inventories would rise by $25,000, while accounts payable would go up by $5,000. All of these costs would be incurred at Year 0. By a special ruling, the machinery could be depreciated under the MACRS system as 3-year property. (See Table 10A.2 at the end of Chapter 10 for MACRS recovery allowance percentages.) The project is expected to operate for four years, at which time it will be terminated. The cash inflows are assumed to begin one year after the project is undertaken, or at t = 1, and to continue out to t = 4. At the end of the project’s life (Year 4), the equipment is expected to have a salvage value of $25,000. Unit sales are expected to total 100,000 five-yard textile rolls per year, and the expected sales price is $2 per roll. Cash operating costs for the project (total operating costs less depreciation) are expected to total 60% of dollar sales. Unilate’s marginal tax rate is 40%, and its required rate of return is 10%. Tentatively, the silk/wool blend fabric project is assumed to be of equal risk to Unilate’s other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks to complete: a. Draw a cash flow timeline that shows when the net cash inflows and outflows will occur, and explain how the time line can be used to help structure the analysis. b. Unilate has a standard form that is used in the capital budgeting process and shown in the following table: © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Unilate’s Silk/Wool Fabric Project ($ Thousands) End of Year: 0 1 2 Unit sales (Thousands) 100 Price/unit $ 2.00 Total revenues $200 Costs excluding depreciation ($120.0) Depreciation Total operating costs $ 2.00 4 100 100 $2.00 $2.00 $200.0 ($120.0) ($120.0) ($120.0) (79.2) (108.0) ( 36.0) ( 16.8) ($199.2) ($228.0) (156.0) (136.8) $44.0 (63.2) Earnings before taxes (EBT) Taxes 100 3 ( 0.8 (8.0) 0.3) 11.2 Net income (17.6) ( 25.3) $26.4 Depreciation 79.2 Supplemental operating CF Equipment cost $ 79.7 108.0 36.0 16.8 91.2 62.4 $ 54.7 (200.0) Installation (40.0) Increase in inventory (25.0) Increase in accounts payable 5.0 Salvage value 25.0 Tax on salvage value (10.0) Return of net working capital 20.0 Cash flow timeline (net CF): ($260.0) $79.7 Cumulative CF for payback: ( 260.0) ( 180.3) $91.2 $62.4 $ 89.7 89.1 (26.7) 63.0 NPV =$4.0 IRR = Payback = Complete the table in the following order: (1) Complete the unit sales, sales price, total revenues, and operating costs excluding depreciation lines. (2) Complete the depreciation line. (3) Now complete the table down to net income and then down to net operating cash flows. © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. KEY COST OF CAPITAL CONCEPTS To conclude this chapter, we summarize some cost of capital concepts (rules) that were discussed. To make appropriate capital budgeting decisions, the firm must know its required rate of return, which is defined as the average rate of return that the firm pays to attract investors' funds. Because the firm pays the average rate of return to investors who provide its long-term funds (capital), the firm's required rate of return is also referred to as its cost of capital. To determine its required rate of return, the firm must compute the cost of each source of funds or capital that investors provide; that is, the firm must compute the cost of debt, the cost of preferred stock, the cost of retained earnings, and the cost of new common equity. These costs are then combined by weighting each component by the proportion or weight that it contributes to the total capital of PROBLEMS 11-1 Global Products plans to issue long-term bonds to raise funds to finance its growth. The company has existing bonds outstanding that are similar to the new bonds it expects to issue. The existing bonds have a face value equal to $1,000, mature in 10 years, pay $60 interest annually, and are currently selling for $1,077 each. Global's marginal tax rate is 40 percent. (a) What should be the coupon rate on the new bond issue? (a) What is Global's after-tax cost of debt? 11-2 Notable Nothings plans to issue new bonds with the same yield as its existing bonds. The existing bonds have a coupon rate of interest equal to 5.6 percent (semiannual interest payments), 12 years remaining until maturity, and a $1,000 maturity value; they are currently selling for $918 each. (a) If Notable issues new bonds today, what will be its before-tax cost of debt? (b) What will be its before- tax cost of debt if the price of its existing bonds is $730 when Notable issues the new bonds? 11-3 Buoyant Cruises plans to issue preferred stock with a $120 par value and a 5 percent dividend. Even though the current market value of its preferred the firm. The result is the weighted average cost of capital, or WACC, which is the required rate of return that the firm should use when making capital budgeting decisions. Investors who participate in the financial markets determine firms' WACCs. Investors only provide funds to firms if they expect to earn sufficient returns on their investments; thus, firms must pay investors' demands (required returns) to attract funds. When investing in capital budgeting projects, a firm should follow the economics principle that asserts products should continue to be manufactured until marginal costs equal marginal revenues. That is, the firm should invest until the marginal cost of capital (marginal costs) equals the internal rate of return on the last project that is purchased (marginal revenues). stock is $80 per share, Buoyant expects to net only $75 for each share issued. What is its cost of issuing preferred stock? The firm's marginal tax rate is 34 percent. 11-4 Jumbo Juice's preferred stock pays a constant divi- dend equal to $4.75 per share. The firm's marginal tax rate is 40 percent. Jumbo Juice incurs a 5 percent flotation cost each time it issues preferred stock. (a) If the firm issues 10,000 shares of preferred stock at $50 per share, how much of the total value of the issue will the firm be able to use (receive)? (b) What is Jumbo Juice's cost of preferred stock? 11-5 Suppose the current risk-free rate of return is 3.5 percent and the expected market return is 9 percent. Fashion Faux-Pas' common stock has a beta coefficient equal to 1.4. Using the CAPM approach, compute the firm's cost of retained earnings. 11-6 Suppose the current risk-free rate of return is 5 percent and the expected market risk premium is 7 percent. Using this information, estimate the cost of retained earnings for a company with a beta coefficient equal to 2.0? CHAPTER 11: The Cost of Capital 223 Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
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CFIN7 - CHAPTER 10
Integrative Problem 10-1
Unilate Textiles is evaluating a new product, a silk/wool blended fabric. Assume that you were recently hired
as assistant to the director of capital budgeting, and you must evaluate the new project.
The fabric would be produced in an unused building adjacent to Unilate’s Southern Pines, North Carolina
plant. Unilate owns the building, which is fully depreciated. The required equipment would cost $200,000,
plus an additional $40,000 for shipping and installation. In addition, inventories would rise by $25,000, while
accounts payable would go up by $5,000. All of these costs would be incurred at Year 0. By a special ruling,
the machinery could be depreciated under the MACRS system as 3-year property. (See Table 10A.2 at the
end of Chapter 10 for MACRS recovery allowance percentages.)
The project is expected to operate for four years, at which time it will be terminated. The cash i...


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