1. Briarcrest Condiments is a spice-making firm. Recently, it developed a new process for producing spices. The process requires new machinery that would cost $2,218,246. have a life of five years, and would produce the cash flows shown in the following table.
Year Cash Flow
1 $560,363
2 -186,636
3 850,806
4 712,176
5 871,134
2. What is the NPV if the discount rate is 14.82 percent? (Enter negative amounts using negative sign e.g. -45.25. Round answer to 2 decimal places, e.g. 15.25.)
NPV is $
3. Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $11.80 million. This investment will consist of $2.80 million for land and $9.00 million for trucks and other equipment. The land, all trucks, and all other equipment is expected to be sold at the end of 10 years at a price of $5.09 million, $2.19 million above book value. The farm is expected to produce revenue of $2.05 million each year, and annual cash flow from operations equals $1.86 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment. (Round intermediate calculations and final answer to 2 decimal places, e.g. 15.25.)
NPV $
The project should be .
4. Bell Mountain Vineyards is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would save the company money, the cost of the system continues to decline. The Bell Mountain’s opportunity cost of capital is 10.2 percent, and the costs and values of investments made at different times in the future are as follows:
Year Cost Value of Future Savings
(at time of purchase)
0 $5,000 $7,000
1 4,650 7,000
2 4,300 7,000
3 3,950 7,000
4 3,600 7,000
5 3,250 7,000
Calculate the NPV of each choice. (Round answers to the nearest whole dollar, e.g. 5,275.)
The NPV of each choice is:
NPV0 = $
NPV1 = $
NPV2 = $
NPV3 = $
NPV4 = $
NPV5 = $
Suggest when should Bell Mountain buy the new accounting system?
Bell Mountain should purchase the system in .
5. Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 83 percent as high if the price is raised 15 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year? (Round answers to nearest whole dollar, e.g. 5,275.)
At $20 per bottle the Chip’s FCF is $ and at the new price Chip’s FCF is $ .
Problem 13.11
Capital Co. has a capital structure, based on current market values, that consists of 33 percent debt, 8 percent preferred stock, and 59 percent common stock. If the returns required by investors are 10 percent, 13 percent, and 19 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)
After tax WACC= %
Q #1/2:
14.82%
-2,218,246 -2,218,246
0 560,363 115.32% 485,920.05
0 -186,636 1.32987024 -140341.51
0 850,856 1.533606361 554807.30
0 712,176 1.768554855 402688.10
0 871,134 2.039497459 427131.69
589,647 (488,040.37)
Question 2
Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12.00 million. This investment will consist of $2.00 million for land and $10.00 million for trucks and other equipment. The land, all trucks, and all other equipment is expected to be sold at the end of 10 years at a price of $5.00 million, $2.12 million above book value. The farm is expected to produce revenue of $2.04 million each year, and annual cash flow from operations equals $1.92 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 9 percent. Calculate the NPV of this investment. (Round intermediate calculations and final answer to 2 decimal places, e.g. 15.25.)
Question 3
Bell Mountain Vineyards is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would save the company money, the cost of the system continues to decline. The Bell Mountain’s opportunity cost of capital is 16.7 percent, and the costs and values of investments made at different times in the future are as follows:
Year Cost Value of Future Savings
(at time of purchase)
0 $5,000 $7,000
1 4,650 7,000
2 4,300 7,000
3 3,950 7,000
4 3,600 7,000
5 3,250 7,000
Calculate the NPV of each choice. (Round answers to the nearest whole dollar, e.g. 5,275.)
The NPV of each choice is:
Question 4
Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 88 percent as high if the price is raised 8 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year? (Round answers to nearest whole dollar, e.g. 5,275.)
Question 5
Capital Co. has a capital structure, based on current market values, that consists of 21 percent debt, 1 percent preferred stock, and 78 percent common stock. If the returns required by investors are 9 percent, 10 percent, and 16 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)
1. To calculate the NPV (Net Present Value) of the cash flows, we need to discount each cash flow to its present value and then subtract the initial investment.
To calculate the present value of each cash flow, we use the formula:
Present Value = Cash Flow / (1 + discount rate)^n
where n is the number of years.
For example, the present value of the cash flow in year 1 would be:
PV1 = $560,363 / (1 + 0.1482)^1 = $489,561.47
Similarly, calculate the present value of the cash flows for years 2 to 5.
Next, we subtract the initial investment from the sum of the present values to calculate the NPV:
NPV = PV1 + PV2 + PV3 + PV4 + PV5 - Initial Investment
Plug in the values and calculate the NPV.
2. To find the NPV with a discount rate of 14.82 percent, follow the steps mentioned in the first explanation.
3. To calculate the NPV of the investment, we need to calculate the present value of cash flows over the 10-year life of the farm and subtract the initial investment.
First, calculate the present value of the annual cash flow from operations for each year using the formula mentioned in the first explanation.
Next, calculate the present value of the expected selling price of land, trucks, and other equipment at the end of 10 years.
Then subtract the initial investment from the sum of the present values calculated in the previous steps to find the NPV.
4. To calculate the NPV of each choice, we use the same steps as mentioned in the first explanation.
Calculate the present value of future savings for each year and subtract the cost at the respective time of purchase.
Compare the NPV of each choice and suggest when Bell Mountain should buy the new accounting system based on the highest NPV.
5. To calculate the effect of the price increase on the firm's FCF (Free Cash Flow) for the year, follow these steps:
First, calculate the current FCF using the given information:
Revenue = Selling price * Quantity sold
Total variable costs = Variable cost per bottle * Quantity sold
Operating income before taxes = Revenue - Total variable costs - Total fixed cash costs
Taxes = Operating income before taxes * Marginal tax rate
FCF = Operating income before taxes - Taxes - Depreciation and amortization charges + Working capital need
Next, calculate the FCF after the price increase:
New revenue = Selling price * Quantity sold * (1 + price increase)
New FCF = New operating income before taxes - Taxes - Depreciation and amortization charges + Working capital need
Finally, calculate the difference between the current FCF and the new FCF to find the effect of the price increase on the firm's FCF.
Problem 13.11:
To calculate the after-tax WACC (Weighted Average Cost of Capital), use the following steps:
Calculate the weighted cost of each component of the capital structure by multiplying the component's weight with its required return.
After-tax WACC = (Weight of Debt * After-tax cost of debt) + (Weight of Preferred Stock * Cost of preferred stock) + (Weight of Common Stock * Cost of common stock)
Multiply the cost of debt by (1 - Tax rate) to get the after-tax cost of debt.
Round the intermediate calculations to 4 decimal places and the final answer to 2 decimal places.