Waban Power Inc. Finance Assingment Help With Solution
1. Answer all questions:
a. Your firm is considering purchasing a new machine that costs $990,000, which can be
depreciated at 30 percent per year (Class 10). The machine would actually be worthless
in five years. The new machine would save $460,000 per year before taxes and
operating costs. Your firm requires a return of 15%. Assuming a tax rate of 40%, what is the NPV of the purchase?
b. Suppose the machine is assigned a 40% CCA rate. All else remaining the same, will NPV be larger or smaller? Give the reason(s) for your answer without actually calculating the NPV.
c. In the question (a) above, suppose now that the machine also requires us to increase
the NWC by $47,200 and that the machine will in fact have a salvage value of $100,000
in five years. What is the new NPV?
2. Answer both questions:
a. Given the following information for Waban Power Inc. and assuming that the company
is subjected to 35 percent tax rate, calculate the company’s weighted average cost of
i. Debt: 8000 6.5 percent coupon bonds outstanding 25 years remaining to
maturity, selling for 106 percent of par; the bonds make semi-annual payments.
ii. Common stock: 310,000 shares outstanding, selling for $57 per share; the beta
iii. Preferred stock: 15,000 shares of 4 percent preferred stock outstanding,
currently selling for $72 per share.
iv. Market: 7 percent market risk premium and 4.5 percent risk-free rate.
b. Saint John Inc. is considering a project that will result in initial after-tax cash savings of $1.8 million at the end of the first year, and that these savings would grow at the rate of 2 percent per year indefinitely. The firm has a target debt-equity ratio of 0.80, a cost of equity of 12 percent and an after-tax cost of debt of 4.8 percent. The cost saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies a discount factor of +2 percent to the cost of capital for risky projects similar to the project under consideration. Under what circumstances should this project be undertaken?
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3. Answer all questions:
a. Explain what is meant by business and financial risk. Suppose Firm A has greater
business risk than Firm B. Is it true that Firm A also has a higher cost of equity? Explain carefully.
b. Augusta Company has a debt-equity ratio of 1.5. Its WACC is 9 percent, and its cost of debt is 5.5 percent. The corporate tax rate is 35 percent.
i. What is the company’s cost of equity capital?
ii. What is the company’s unlevered cost of equity capital?
iii. What would the cost of equity be if the debt-equity ratio were 2? What if it
were 1.0? What if it were zero?
iv. Algeria & Co. expects its EBIT to be $74,000 every year forever. The firm can
borrow at 7 percent. Algeria & Co. has no debt, and its cost of equity is 12
percent. If the tax rate is 35%, what is the value of the firm? What will the value
be if the company borrows $125,000 and uses the proceeds to repurchase
4. Answer all questions:
a. How is it possible that dividends are so important, but, at the same time, dividend policy could be irrelevant? If increases in dividend tend to be followed by (immediate)
increases in share prices, how can it be said that dividend policy is irrelevant?
b. Experience shows that relatively few firms making initial public offerings of common
stock pay cash dividends. Why do you think that most such firms choose not to pay cash
c. The statement of financial position for Voxx Corp. is shown below in market value
terms. There are 9000 shares of stock outstanding.
Market Value Statement of Financial Position
Cash $ 43,700 Equity $353,700
Fixed assets 310,000
Total $353,700 Total $353,700
I. The company has declared a dividend of $1.40 per share. The stock goes exdividend
tomorrow. Ignoring any tax effects, what is the stock selling for today?
II. What will it sell for tomorrow? Why?
III. What will the statement of the financial position look like after the dividends
are paid out?
5. You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner. It is quite common for companies to lease expensive, high-tech gear. The scanner costs $6.3 million and it qualifies for a 30 percent CCA rate. The equipment will be valueless in four years.
You can lease it for $1.875 million per year for four years. Assume that the asset pool remains open and payments are made at the end of the year.
a. Assume that the tax rate is 37 percent, and that you can borrow at 7.5 percent per year pre-tax. Should you lease or borrow? Explain your answer.
b. What are the cash flows from the lessor’s point of view? Assume a 37 percent tax
c. Go back to 5.a above. If the asset pool remains open, but the scanner qualifies for a special 50 percent CCA rate per year. Will you lease or buy?
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