Question 16 A. X-treme Vitamin Company is considering two investments, both of w
ID: 2789736 • Letter: Q
Question
Question 16
A. X-treme Vitamin Company is considering two investments, both of which cost $20,000. The firm’s cost of capital is 15 percent. The cash flows are as follows:
(a) What is the payback period for each project? Which project would you accept based on the payback period?
(b) What is the discounted payback for each project? Which project would you accept based on the discounted payback criterion?
(c) Calculate the NPV of each project? Which project would you choose based on the NPV criterion?
(d) Based on the IRR criteria which project would you choose if they were mutually exclusive?
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Year
Project A
Project B
1
12,000
10,000
2
Error! Filename not specified.
8,000
Error! Filename not specified.
Error! Filename not specified.
6,000
Error! Filename not specified.
3
6,000
16,000
Show all workings.
Question 17
The following balance sheet extract relates to the ABC Company.
Additional Information:
The bonds are 8%, annual coupon bonds, with 9 years to maturity and are currently selling for 90% of par.
The company’s common shares which have a book value of $25 per share are currently selling at $22 per share. The beta on the company’s stock is 1.10
Preferred shares have a book value of $100 per share. These shares are currently selling
A.
Page 3
at $115 per share and carries a
Market Risk premium is 6 % and 4% is the risk-free rate.
The company’s Tax rate is 30%
Required: Determine the following for the company
(a) Total Market value(b) After-tax Cost of Debt (c) Cost of Common Stock (d) Cost of Preferred Stock (e) W ACC
B. What is the best proxy for the risk-free rate when using the CAPM to calculate the cost of equity? Explain the reasons for your answer.
Question 18
The following questions are independent of each other.
Miller Brothers Ltd has bonds outstanding that matures in 7 years and pays a 6 percent semi- annual coupon.
(a) What will the bond price be for one of these bonds if the par value is $1,000 and the market interest rate is 8.0 percent?
(b) Calculate and explain what would happen to the value of the bond if the market interest rate falls to 6.0 percent.
Assume you will receive $2,000 a year in Years 1 through 5, $3,000 a year in years 6 through 8, and $4,000 in year 9 with all cash flows to be received at the end of the year. If you require a return of 14 percent annually, what is the present value of these cash flows? Go-geta Corp. issued 10-year bonds 2 years ago at a coupon rate of 6 percent. The bonds make semiannual payments.
(a) If these bonds currently sell for 98 percent of par value, what is the YTM? (b) List the key features of a bond.(c) Explain what is meant by net proceeds in the context of a bond sale.
Year
Project A
Project B
1
12,000
10,000
2
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8,000
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Error! Filename not specified.
6,000
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3
6,000
16,000
Explanation / Answer
a payback period of the project project a years 1 2 3 cash flows 12000 8000 6000 cumulative cash flows 12000 20000 26000 payback period is the time require to collect the cost of the project in this case it takes 2 year to collect the 20000 payback period 2 years project b years 1 2 3 cash flows 10000 6000 16000 cumulative cash flows 10000 16000 32000 cumulative cash flows up to 2 years 16000 balance amount to be recovered in 3 rd year 20000 - 16000 balance amount to be recovered in 3 rd year 4000 time required in 3 rd year to collect the balance cash flows 4000 / 16000 time required in 3 rd year to collect the balance cash flows 0.25 payback period 2 years + 0.25 years payback period 2.25 years as per the payback period the project a will be accepted as the payback period is less b discounted payback period of the project project a years 1 2 3 cash flows 12000 8000 6000 PVRF at 15 % 0.8696 0.7561 0.6575 present value cash flows 10435 6049 3945 cumulative cash flows 9074 15123 19068 payback period is the time require to collect the cost of the project in this case the 20000 has not be collected with in the project period project b years 1 2 3 cash flows 10000 6000 16000 PVRF at 15 % 0.8696 0.7561 0.6575 present value cash flows 8696 4537 10520 cumulative cash flows 7561 12098 22619 cumulative cash flows up to 2 years 12098 balance amount to be recovered in 3 rd year 20000 - 12098 balance amount to be recovered in 3 rd year 7902 time required in 3 rd year to collect the balance cash flows 7902 / 10520 time required in 3 rd year to collect the balance cash flows 0.751140684 payback period 2 years + 0.75 payback period 2.75 years as per the payback period the project b will be accepted as the payback period is less calculation of the net present value of the project project a years 1 2 3 cash flows 12000 8000 6000 PVRF at 15 % 0.8696 0.7561 0.6575 present value cash flows 10435 6049 3945 total present value cash flows 20429 cash outflow 20000 net present value ( 20429 - 20000 ) 429 project b years 1 2 3 cash flows 10000 6000 16000 PVRF at 15 % 0.8696 0.7561 0.6575 present value cash flows 8696 4537 10520 total present value cash flows 23753 cash outflow 20000 net present value ( 23753 - 20000 ) 3753 based on the net present value project b will be selected as the net present value is high d calculation of internal rate of return years 0 1 2 3 cash flows -20000 12000 8000 6000 internal rate of return using excel .=irr(cash flows form year 0 to year 3 ) 16.46% project b years 0 1 2 3 cash flows -20000 10000 6000 16000 internal rate of return using excel .=irr(cash flows form year 0 to year 3 ) 25.10% as per the internal rate of return project b will be selected as the irr of b is high
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