The final exam has a total of 11 questions as you can see. You must complete 10 of the 11! Each question has a point value of 10 points. Please respond to the discussion questions as completely as you can. On the numerical problems, please show each step to your final solution.

1) As a manager evaluating capital investment projects, what hurdle rate of return is appropriate to use when calculating NPV and under which circumstances? That is, we have discussed the WACC and you know that reflects the average cost of raising funds from suppliers of capital. So what rate should a manager use in evaluating a capital investment project for the firm and why?

2) Your company purchased a piece of land five years ago for $150,000 and subsequently added $175,000 in improvements. The current book value of the property is $225,000. There are two options for future use of the land: 1) the land can be sold today for $375,000 after-tax; or 2) your company can destroy the past improvements and build a factory on the land. In consideration of the factory project, what amount (if any) should the land be valued at for purposes of the capital budgeting analysis? Explain your rationale.

3) Your company currently sells oversized golf clubs. The Board of Directors wants you to look at replacing them with a line of super-sized clubs. Briefly explain whether the following are relevant cash flows to this analysis and if so, how those cash flows can affect any decision. Discuss each item individually.

a. $300,000 drop in sales from terminating the oversized line of clubs

b. $750,000 in land you own that may be used for the project

c. $200,000 spent on Research and Development last year on oversized clubs

d. $350,000 you will pay to Fred Singles to promote your new clubs

e. $125,000 you will receive by selling the existing production equipment which must be replaced

4)a) Would a firm undertake an investment with an NPV of zero? If so, why? What does it mean if the NPV is exactly equal to zero?

b) How can firms position new ventures to have NPVs of greater than zero? What are some strategies for that? We discussed this in the lecture.

5) Why are interest charges on debt not deducted when determining a project’s net cash flows as part of the capital budgeting process?

6) In terms of the capital structure of a firm, we know that there are significant differences among industries and even among firms within industries. Discuss the factors that go into the determination of the “optimal” level of debt a firm should carry. List firm specific factors and then discuss. That is, what consideration must you make when determining how much debt your firm can handle? Think about this some before answering.

7) Assume two mutually exclusive investments have the following cash flows:

Project Year 0 Year 1 Year 2 Year 3

Project A -$200 $100 $100 $100

Project B -$300 $150 $125 $150

Complete the following table assuming that the cost of capital is 10%:SHOW ALL WORK!

Project A

Project B Under this Investment Criteria which project would you choose?

(Enter A or B)

NPV

IRR

Payback

MIRR

Profitability Index

Based on your answers in the table above, which project would you finally choose and why? Be sure to show your work.

8) The president of Speedy Copy has asked you to evaluate the proposed acquisition of a new copier. The copier equipment is expected to cost $30,000 and will be depreciated in a straight-line manner for the three years of the asset’s life after which it will be worthless. Use of the equipment will require an increase in net working capital (additional paper sizes which can be accommodated by the new copier) of $4,000. Increased sales from Auburn University Finance faculty looking for a working copier are expected to be $20,000 per year with operating costs (excluding depreciation) of $5,000 per year. Calculate the initial outlay and net cash flows for years 1-3. In other words, show the net cash flows for t=0, t=1, t=2, and t=3. Speedy Copy’s marginal tax rate is 40 percent.

9) Hollingsworth Candy Products has an inventory turnover of six times per year, a receivables turnover of 10 times, and a payables turnover of 12 times. What is Hollingsworth’s inventory conversion period, the receivables collection period, and its payables deferral period? What is its cash conversion cycle?Explain what this means to managers and why is this important?

10)The Empire Manufacturing is considering acquisition of a new press machine for their manufacturing facility in Pennsylvania. They have two machines from which to select. Alternative A has a cost of $120,000. The net cash flow benefit in terms of added efficiency from Alternative A amount to $65,000 per year for 3 years. Empire is also considering Alternative B which will cost $170,000. Once in operation, they project that it will produce benefits of $70,000 per year for 4 years. Inflation is expected to be zero during the next 4 years. If cash inflows occur at the end of each year, and if the cost of capital is 12%, which of the two alternatives is will add the most value? Show your calculations and work. Note that A is a 3 year project while B is a 4 year project.

11) A firm is planning for the next year and wants you to provide a forecast of the firm’s additional funds needed (AFN). The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the Additional Funds Needed (AFN) for the coming year? Dollars are in millions.Explain what this means to managers.

Last year’s sales = S0 $350 Last year’s accounts payable $40

Sales growth rate = g 30% Last year’s notes payable $50

Last year’s total assets = A0* $500 Last year’s accruals $30

Last year’s profit margin = PM 5% Target payout ratio 60%

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