1)Your division is considering two projects with
the following cash flows (in millions):
|
0 |
1 |
2 |
3 |
|
Project |
-$20 |
$5 |
$9 |
$12 |
|
Project |
-$13 |
$8 |
$7 |
$3 |
a.
What are the projects’ NPVs assuming the WACC is 5%? Round your
answer to two decimal places. Enter your answer in millions. For example, an
answer of $10,550,000 should be entered as 10.55.
Project A $ million
Project B $ million
What are the projects’ NPVs
assuming the WACC is 10%? Round your answer to two decimal places. Enter your
answer in millions. For example, an answer of $10,550,000 should be entered as
10.55.
Project A $ million
Project B $ million
What are
the projects’ NPVs assuming the WACC is 15%? Round your answer to two decimal
places. Enter your answer in millions. For example, an answer of $10,550,000
should be entered as 10.55.
Project A $ million
Project B $ million
b.
What are the projects’ IRRs assuming the WACC is 5%? Round your
answer to two decimal places.
Project A %
Project B %
What are the projects’ IRRs
assuming the WACC is 10%? Round your answer to two decimal places.
Project A %
Project B %
What are
the projects’ IRRs assuming the WACC is 15%? Round your answer to two decimal
places.
Project A %
Project B %
c.
If the WACC were 5% and A and B were mutually exclusive, which
would you choose? (Hint: The crossover rate is 3.86%.)
If the WACC were 10% and A
and B were mutually exclusive, which would you choose? (Hint: The
crossover rate is 3.86%.)
If the
WACC were 15% and A and B were mutually exclusive, which would you choose? (Hint:
The crossover rate is 3.86%.)
2.) An electric utility is considering a new power plant in northern
Arizona. Power from the plant would be sold in the Phoenix area, where it is
badly needed. Because the firm has received a permit, the plant would be legal;
but it would cause some air pollution. The company could spend an additional
$40 million at Year 0 to mitigate the environmental Problem, but it would not
be required to do so. The plant without mitigation would cost $210.55 million,
and the expected cash inflows would be $70 million per year for 5 years. If the
firm does invest in mitigation, the annual inflows would be $75.77 million.
Unemployment in the area where the plant would be built is high, and the plant
would provide about 350 good jobs. The risk adjusted WACC is 16%.
a.
Calculate the NPV and IRR with mitigation. Round your answers to
two decimal places. Enter your answer for NPV in millions. For example, an
answer of $10,550,000 should be entered as 10.55.
NPV $ million
IRR %
Calculate
the NPV and IRR without mitigation. Round your answers to two decimal places.
Enter your answer for NPV in millions. For example, an answer of $10,550,000
should be entered as 10.55.
NPV $ million
IRR %
b.
How should the environmental effects be dealt
with when evaluating this project? (Please
Choose One)
I.
The environmental effects should be ignored since the plant is
legal without mitigation.
II.
The environmental effects should be treated as a sunk cost and
therefore ignored.
III.
If the utility mitigates for the environmental effects, the
project is not acceptable. However, before the company chooses to do the
project without mitigation, it needs to make sure that any costs of “ill will”
for not mitigating for the environmental effects have been considered in that
analysis.
IV.
The environmental effects should be treated as a remote
possibility and should only be considered at the time in which they actually
occur.
V.
The environmental effects if not mitigated would result in
additional cash flows. Therefore, since the plant is legal without mitigation,
there are no benefits to performing a “no mitigation” analysis.
c. Should
this project be undertaken? (Please
Choose One)
I.
The project should be undertaken only under the
“mitigation” assumption.
II.
The project should be undertaken since the IRR is positive under
both the “mitigation” and “no mitigation” assumptions.
III.
The project should be undertaken since the NPV is positive under
both the “mitigation” and “no mitigation” assumptions.
IV.
Even when no mitigation is considered the project has a negative
NPV, so it should not be undertaken.
V.
The project should be undertaken only if they do not mitigate for
the environmental effects. However, they want to make sure that they’ve done
the analysis properly due to any “ill will” that might result from
undertaking the project without concern for the environmental impacts.
3.) A
mining company is considering a new project. Because the mine has received a permit,
the project would be legal; but it would cause significant harm to a nearby
river. The firm could spend an additional $10.33 million at Year 0 to mitigate
the environmental Problem, but it would not be required to do so. Developing
the mine (without mitigation) would cost $63 million, and the expected net cash
inflows would be $21 million per year for 5 years. If the firm does invest in
mitigation, the annual inflows would be $22 million. The risk adjusted WACC is
13%.
a.
Calculate the NPV and IRR with mitigation. Round your answers to
two decimal places. Enter your answer for NPV in millions. For example, an
answer of $10,550,000 should be entered as 10.55.
NPV $ million
IRR %
Calculate
the NPV and IRR without mitigation. Round your answers to two decimal places.
Enter your answer for NPV in millions. For example, an answer of $10,550,000
should be entered as 10.55.
NPV $ million
IRR %
b.
How should the environmental effects be dealt with when this
project is evaluated?
I.
The environmental effects should be ignored since the mine is
legal without mitigation.
II.
The environmental effects should be treated as a sunk cost and
therefore ignored.
III.
The environmental effects if not mitigated would result in
additional cash flows. Therefore, since the mine is legal without mitigation,
there are no benefits to performing a “no mitigation” analysis.
IV.
The environmental effects should be treated as a remote
possibility and should only be considered at the time in which they actually
occur.
V.
The environmental effects if not mitigated could result in
additional loss of cash flows and/or fines and penalties due to ill will among
customers, community, etc. Therefore, even though the mine is legal without
mitigation, the company needs to make sure that they have anticipated all costs
in the “no mitigation” analysis from not doing the environmental
mitigation.
c.
Should this project be undertaken?
If so, should the firm do
the mitigation?(Please Chose One)
I.
Under the assumption that all costs have been considered, the company
would mitigate for the environmental impact of the project since its NPV with
mitigation is greater than its NPV when mitigation costs are not included in
the analysis.
II.
Under the assumption that all costs have been considered, the
company would not mitigate for the environmental impact of the project since
its NPV without mitigation is greater than its NPV when mitigation costs are
included in the analysis.
III.
Under the assumption that all costs have been considered, the
company would mitigate for the environmental impact of the project since its
IRR with mitigation is greater than its IRR when mitigation costs are not
included in the analysis.
IV.
Under the assumption that all costs have been considered, the
company would not mitigate for the environmental impact of the project since
its NPV with mitigation is greater than its NPV when mitigation costs are not
included in the analysis.
V.
Under the assumption that all costs have been considered, the
company would not mitigate for the environmental impact of the project since
its IRR without mitigation is greater than its IRR when mitigation costs are
included in the analysis.
4.) Kim Inc. must install a new air conditioning unit in its main
plant. Kim must install one or the other of the units; otherwise, the highly
profitable plant would have to shut down. Two units are available, HCC and LCC
(for high and low capital costs, respectively). HCC has a high capital cost but
relatively low operating costs, while LCC has a low capital cost but higher
operating costs because it uses more electricity. The costs of the units are
shown here. Kim’s WACC is 5.5%.
|
0 |
1 |
2 |
3 |
4 |
5 |
|
HCC |
-$610,000 |
-$45,000 |
-$45,000 |
-$45,000 |
-$45,000 |
-$45,000 |
|
LCC |
-$110,000 |
-$180,000 |
-$180,000 |
-$180,000 |
-$180,000 |
-$180,000 |
a. Which
unit would you recommend?
I.
Since we are examining costs, the unit chosen would be the one
that had the lower PV of costs. Since LCC’s PV of costs is lower than HCC’s,
LCC would be chosen.
II.
Since we are examining costs, the unit chosen would be the one
that had the lower PV of costs. Since HCC’s PV of costs is lower than LCC’s,
HCC would be chosen.
III.
Since all of the cash flows are negative, the IRR’s will be
negative and we do not accept any project that has a negative IRR.
IV.
Since all of the cash flows are negative, the NPV’s cannot be
calculated and an alternative method must be employed.
V.
Since all of the cash flows are negative, the NPV’s will be
negative and we do not accept any project that has a negative NPV.
b. If Kim’s
controller wanted to know the IRRs of the two projects, what would you tell
him?
I.
The IRR cannot be calculated because the cash flows are all one
sign. A change of sign would be needed in order to calculate the IRR.
II.
The IRR cannot be calculated because the cash flows are in the
form of an annuity.
III.
The IRR of each project will be positive at a lower WACC.
IV.
There are multiple IRR’s for each project.
V.
The IRR of each project is negative and therefore not useful for
decision-making.
c. If the
WACC rose to 11% would this affect your recommendation?
I.
When the WACC increases to 11%, the IRR for LCC is greater than
the IRR for HCC, LCC would be chosen.
II.
When the WACC increases to 11%, the IRR for HCC is greater than
the IRR for LCC, HCC would be chosen.
III.
Since all of the cash flows are negative, the NPV’s will be
negative and we do not accept any project that has a negative NPV.
IV.
When the WACC increases to 11%, the PV of costs are now lower for
LCC than HCC.
V.
When the WACC increases to 11%, the PV of costs are now lower for
HCC than LCC.
Explain your answer and why this result occurred.
VI.
The reason is that when you discount at a higher rate you are
making negative CFs higher thus improving the IRR.
VII.
The reason is that when you discount at a higher rate you are
making negative CFs higher thus improving the NPV.
VIII.
The reason is that when you discount at a higher rate you are
making negative CFs higher and this lowers the NPV.
IX.
The reason is that when you discount at a higher rate you are
making negative CFs smaller and this lowers the NPV.
X.
The reason is that when you discount at a higher rate you are
making negative CFs smaller thus improving the NPV.
5.) The future earnings, dividends, and common stock price of
Carpetto Technologies Inc. are expected to grow 5% per year. Carpetto’s common
stock currently sells for $24.50 per share; its last dividend was $2.00; and it
will pay a $2.10 dividend at the end of the current year.
a. Using the
DCF approach, what is its cost of common equity? Round your answer to two
decimal places.
%
b. If the
firm’s beta is 1.40, the risk-free rate is 8%, and the average return on the
market is 12%, what will be the firm’s cost of common equity using the CAPM
approach? Round your answer to two decimal places.
%
c. If the
firm’s bonds earn a return of 12%, based on the bond-yield-plus-risk-premium
approach, what will be rs? Use the midpoint of the risk premium
range discussed in Section 10-5 in your calculations. Round your answer to two
decimal places.
%
d. If you
have equal confidence in the inputs used for the three approaches, what is your
estimate of Carpetto’s cost of common equity? Round your answer to two decimal
places.
%
6.)
Midwest Electric Company (MEC) uses only debt
and common equity. It can borrow unlimited amounts at an interest rate
of rd = 9% as long as it finances at its target
capital structure, which calls for 50% debt and 50% common equity. Its last
dividend (D0) was $2.45, its expected constant growth rate is 5%,
and its common stock sells for $21. MEC’s tax rate is 40%. Two projects are
available: Project A has a rate of return of 14%, while Project B’s return is
11%. These two projects are equally risky and about as risky as the firm’s
existing assets.
a. What is
its cost of common equity? Round your answer to two decimal places.
%
b. What is
the WACC? Round your answer to two decimal places.
%
c. Which
projects should Midwest accept?
