Question

please show calcultions, thanks!

88,000 23002 144,000 Cash flows from financing activities Issuance of common stock Retirement of notes payable Payment of dividends Net cash provided by financing activities: Net increase in cash Cash at beginning of year Cash at end of year 2. Manchester Eyewear, Inc, manufactures glasses. Manchester is considering purchasing a new piece of manufacturing equipment for $2,000,000. The equipment is expected to last 10 years, and management projects that purchasing the equipment would result in an additional $300,000 in pre-tax cash flow per year. Management does not expect the equipment to have any value at the end of 10 years, and so will fully depreciate the equipment on a straight-line basis (45 points). To obtain the funds to purchase this equipment. Manchester plans to raise capital from the following sources: Bank Loan: Bond Financing Preferred Stock (10%) Issuance $800,000 at an interest rate of 7.25% $600,000 at an interest rate of 7% $600,000 Manchester's tax rate is 20% (Continued on next page)

Answer 1

a) As there is an uniform annual cash flows including depreciation tax shield over next 10 years, discount factor that must be used to calculate present value of future cash flows at firm's WACC of 7% as discount rate will be "Present value of an annuity of $1". Therefore, 15% 1 6% 57% Under straight-line method, Annual depreciation expense = Depreciable cost / Useful life of the asset; Tax shield on depreciation expense = Depreciation expense x Tax rate. Present value of an annuity of $1: Depreciation expense $200,000 [$2,000,000 / 10 years] Period 20% 0.9524 Tax rate 0.9434 1.8594 1.8334 Tax shield on depreciation expense $40,000 [$200000 x 20%] 2.7232 2.6730 $300,000 (Given] 3.5460 Pre-tax cash flows per year 3.4651 4.3295 4.2124 Annual before-tax cash flows $340,000 5.0757 4.9173 20% 5.7864 Tax rate 5.5824 6.4632 6.2098 Annual after-tax cash flows $272,000 ($340000 x (1-20%)] 7.1078 6.8017 PV of annuity of $1 at 7% for 10 periods 7.0236 7.72177 .3601 Present Value of future cash flows $1,910,419 ($272000 x 7.0236] Less: Initial investment required $2,000,000 Net Present Value (NPV) $89,581 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 b) As the NPV is negative, the company should not make the investment. Reason: Negative NPV implies that present value of future net cash inflows is not sufficient to absorb initial investment made today and so should not be invested.

Workings: Source After-tax cost of debt = Before-tax cost of debt x (1 - Tax rate) Capital Structure 0.4 Bank Loan Bond Financing Preferred Total value $800,000 $600,000 $600,000 $2,000,000 0.3 [$800000 / $2000000] [$600000 / $2000000] [$600000 / $2000000] Bank Loan 7.25% 20% 5.8% Before-tax cost of debt Tax Rate After-tax Annual cost of debt Bonds 7% 20% 5.6% 0.3 [7.25% x (1-20%) = 5.8%; 7% x (1-20%) = 5.6%] (u) (v) (u) x (v) Source Capital Structure Cost (Ref: NOTE) Weighted Cost Bank Loan 0.4 5.8% Bond Financing 0.3 5.6% Preferred 0.3 10.0% Company's WACC (= discount rate) 2.32% 1.68% 3.00% 7.00% (0.4 x 5.8%] (0.3 x 5.6%] [0.3 x 10%] [2.32% + 1.68% + 3%]