Question no 1

Tennessee-Atlantic Paper Company is considering a new linerboard machine costing $2 million.

It is expected to produce after-tax savings of $400,000 per year for eight years. The required rate
of return on unlevered equity is 13 percent to an all-equity-financed firm. Under these
circumstances the project would be either rejected or accepted. Wally Bord, plant manager at the
linerboard mill, is heartbroken if the project rejected, because he really wanted the new machine.
But, all is not lost! After all, it is the policy of the company to finance capital investment projects
with 50 percent debt, because that is the target debt to total capitalization of the company.
Tennessee-Atlantic Paper Company is able to borrow $1 million at 10 percent interest to finance
part of the new machine. (The balance will come from equity funds.) The principal amount of the
loan will be repaid in equal year-end instalments through the end of the eighth year. If the
company’s tax rate equals 40 percent, to compute the tax-shield benefits of interest and their
present value. Suppose that Tennessee-Atlantic incurs after-tax flotation costs (in present value
terms) of $40,000.
a) calculate adjected present value and decide whether the project would be acceptable or not?
b) calculate APV if saving declined by $ 50000.

Question no done
After careful analysis, Dexter Brothers has determined that its optimal capital structure is
composed of the sources and target market value weights shown in the following table.

Source of capital Target Market value weight

Long-term debt 30%

Preferred stock 15

55
Common stock equity

Total 100%

The cost of debt is estimated to be 7.2%; the cost of preferred stock is estimated to be 13.5%; the
cost of retained earnings is estimated to be 16.0%; and the cost of new common stock is
estimated to be 18.0%. All of these are after-tax rates. The company’s debt represents 25%, the
preferred stock represents 10%, and the common stock equity represents 65% of total capital on
the basis of the market values of the three components. The company expects to have a
significant amount of retained earnings available and does not expect to sell any new common
stock.
a. Calculate the weighted average cost of capital on the basis of historical market value weights.
b. Calculate the weighted average cost of capital on the basis of target market value weights.
c. Compare the answers obtained in parts a and b. Explain the differences.

Question no 1 Done
a) Explain the strategic decision of finance from corporate prospective.
b) MR A is appointed as a financial consultant of the company XYZ. He is currently make
investment decision. For this purpose, he wants to purchase more technological advanced
machine to replace the machine currently being used in its production process. The firm’s
production engineers contend that the newer machine will turn out the current volume of output
more efficiently. They note the following facts in support of their contention. The old machine
can be used for four more years. It has a current salvage value of $8,000, but if held to the end of
its useful life, the old machine would have an estimated final salvage value of $2,000. This is the
final year that tax depreciation will be taken on the machine, and the amount of depreciation is
equal to the machine’s remaining depreciated (tax) book value of $4,520. The new, advanced
machine purchase price of $60,000 with 2 transportations and 3 installation cost. Its final salvage
value is projected to be $15,000 at the end of its four-year useful life. The new machine falls into
the three-year property category for MACRS depreciation. The new machine will reduce labor
and maintenance usage by $12,000 annually. Income taxes on incremental profits are paid at a
40 percent rate. Calculate the expected annual incremental cash flows for years 1 through 4, as
well as the estimated initial cash outflow and terminal cash flow.
Question no 2 Done
Briarcliff Stove Company is considering a new product line to supplement its range line. It is
anticipated that the new product line will involve cash investment of $700,000 at time 0 and $1.0
million in year 1. After-tax cash inflows of $250,000 are expected in year 2, $300,000 in year 3,
$350,000 in year 4, and $400,000 each year thereafter through year 10. Though the product line
might be viable after year 10, the company prefers to be conservative and end all calculations at
that time.
If the required rate of return is 15 percent, what is the net present value of the project? Is it
acceptable?

Question no 3
Xonics Graphics, Inc., is evaluating a new technology for its reproduction equipment. The
technology will have a three-year life, will cost $1,000, and will have an impact on cash flows
that is subject to risk. Management estimates that there is a fifty-fifty chance that the technology
will either save the company $1,000 in the first year or save it nothing at all. If nothing at all,
savings in the last two years would be zero as well. Even here there is some possibility that in the
second year an additional outlay of $300 would be required to convert back to the original
process, for the new technology may decrease efficiency. Management attaches a 40 percent
probability to this occurrence if the new technology “bombs out” in the first year. If the
technology proves itself in the first year, it is felt that second-year cash flows will be $1,800,
$1,400, and $1,000, with probabilities of 0.20, 0.60, and 0.20, respectively. In the third year,
cash flows are expected to be either $200 greater or $200 less than the cash flow in period 2,
with an equal chance of occurrence. (Again, these cash flows depend on the cash flow in period
1 being $1,000.)
Requirement: What is the risk of the project