Question

12) asset investment of $1.0 million. The fixed asset will be depreciated straight-line to zero over its four-year tax life, after which time it will have a zero market value. The project is estimated to generate S1500,000 in annual sales, with costs of $1,200,000. The tax rate is 40 percent and the required return for the project is 10 percent. What is the net present value? StarShine is considering a new four-year expansion project that requires an initial fixed A) $166,106.62 B) -$186,937 ) $280,000.00 $112,437.68 13) Star Donuts has a target debt-equity ratio of 0.20. Its cost of equity is 12 percent, and its pretax cost of debt is 6 percent. What is the firm's WACC given a tax rate of 40 percent? A) 10.32 percent B) 10.01 percent C) 10.60 percent 10.80 percent Sponge Bob uses 65 percent common stock and 35 percent debt to finance its operations. 14) The after-tax cost of debt is 5.8 percent and the cost of equity is 16.1 percent. Management is considering a project that will produce a cash inflow of $42,000 in the first year. The cash inflows will then grow at 3 percent per year forever What is the maximum amount can initially invest in this project to avoid a negative net present value for the the firm project? ) $442,338 B) $455,608 C) $497,608 D) $420,000 15) Assigning discount rates to individual projects based on the risk level of each project A) Will cause the firm's overall cost of capital to decrease over time. B) Will cause the weighted average cost of capital to increase or decrease. Negates the firm's goal of creating the most value for the shareholders. D) Will prevent the firm's overall cost of capital from changing over time. 16) A company that utilizes the MACRS system of depreciation A) Will expense less than the entire cost of an asset. B) Will have a greater depreciation tax shield in earlier years. C) Will fully depreciate a MACRS 5-year asset within 5 years. D) Will have equal depreciation costs each year of an asset's life.

Answer 1

Solution 12)

All amounts are in million USD.

Year		1	2	3	4
Revenue inflows		1.5	1.5	1.5	1.5
Costs outflows	–	1.2	1.2	1.2	1.2
Before-tax net cash flows		0.3	0.3	0.3	0.3
Depreciation	–	0.25	0.25	0.25	0.25
Income before taxes		0.05	0.05	0.05	0.05
Taxes @ 40%	–	0.02	0.02	0.02	0.02
After-tax net income		0.03	0.03	0.03	0.03
Depreciation	+	0.25	0.25	0.25	0.25
After-tax cash flows		0.28	0.28	0.28	0.28
Present value of cash flows		1.618	2.83	3.94	4.94
Total present value		13.328

Net Present Value=PV of Cash flows – Initial Outlay

NPV=$13.328 mn-$1 mn

NPV=$12.328 mn

Solution 13) Given:-

D/E=0.2 (=>D=0.2E)

Cost of equity,K_e=12%

Pre-tax Cost of debt,K_d=6%

Tax,t=40%

Cash Inflow, FCFE₁=$42000

Growth rate to perpetuity, g=3%

Value of Firm,$V=D+E$

$V=0.2E+E$ or

0.2

$V=1.2E$ or $V=6D$

To calculate WACC,

${\color{Red} WACC=\left [K_{e}\times \frac{E}{V} \right ]+\left [K_{d}\times \frac{D}{V}\times \left ( 1-t \right ) \right ]}$

WACC= 10.12 × TDE + 1.06 × 6D × (1-0.4) 1.2E

WACC = 0.1 + 0.006

${\color{Blue} WACC=0.106}$ or 10.6%.

Solution 14) Given:-

Weight of Common stock or Equity, W_e=0.65

Weight of debt, W_d=0.35

After tax cost of Debt, K_d(1-t)=5.8%

Cost of Equity, K_e=16.1%

${\color{Red} WACC=\left [K_{e}\times W_{e} \right ]+\left [K_{d} \times \left ( 1-t \right )\times W_{e} \right ]}$

$WACC=\left [0.161\times 0.65 \right ]+\left [0.058\times 0.35 \right ]$

WACC0.10465 0.0203

$WACC=0.12495$ or 12.49%

To avoid negative NPV, the maximum initial investment should be,

${\color{Red} Initial Investment=\frac{ FCFE_{1}}{WACC-g}}$

$42000 InitialInvestt0,12495 -0.03 0.12495-0.03

$Initial Investment=\frac{\$ 42000}{0.09495}$

${\color{Blue} Initial Investment=\$ 442338.07}$

Solution 15) Option B is the answer.

Assigning discount rates to individual projects based on their risk level will cause WACC to either increase or Decrease.

Solution 16)Option B is the answer

Company that utilizes MACRS(Modified Accelerated Cost Recovery System) system of depreciation will have greater depreciation tax shield in early years and less in later years , this is being done to encourage capital investments.