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Corporate Finance Assignment # 1 Topic: CAPITAL BUDGETING

Q.1:- Lights-Out Electric Company is considering a contract to manufacture a specialized light switch.The contract calls for the company to deliver 3000 switches per year for 4 years at a price of $30per switch (paid on delivery). Producing the switch will require the use of some existingequipment and investment of $100,000 in new equipment. The variable cost of the switch willbe $15 per switch throughout the life of the contract. The existing equipment that would be used is already fully depreciated. If used to makeswitches, it will not require any maintenance expenditures but it will be worthless at the end ofthe contract. The company has no other use for the equipment but could sell it now for $10,000. The new equipment that would be used on the switch contract requires no maintenanceexpenditures but will be depreciated to zero on a straight-line basis over 4 years. At the end of 4years, this equipment can be sold for $15,000. The cost of capital (RRR) for this project is 10%. Lights-Out’s tax rate is 33%. Should LightsOut takethe switch contract?Assume that all CFs except the initial equipment-related flows occur at the end of years 1. Calculate the Net present value of the contract. Q.2:-NPV and Discount Rates An investment has an installed cost of $412,670.The cash flows over the four-year life of the investment are projected to be$212,817, $153,408, $102,389, and $72,308. If the discount rate is zero, what isthe NPV? If the discount rate is infinite, what is the NPV? At what discount rateis the NPV just equal to zero? Sketch the NPV profile for this investment basedon these three points. Q.3:-The president of ABC Inc. has asked you to evaluate the proposed acquisition of a new computer.The computer’s price is $40,000 and it falls into the MACRS 3-year class.Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm’s before-tax revenues by $20,000 per year but would also increase

operating costs by $5,000 per year. The computer is expected to be used for three years and then be sold for $25,000. The firm’s marginal tax rate is 40%, and the project’s cost of capital is 14% 1. What is the net investment required at t = 0? 2. What is the operating cash flow in Year 1, 2 and 3? 3. What is the total value of the terminal year non-operating cash flows at the end of Year 3? 4. What is the project’s NPV? Q.4:- Let us assume the following. A supervisor of a printing company finds that preliminary investment of printing machinery is $200000. The machinery will be devalued once in five years with scrap value of zero. He also estimates that increment in revenue or income from the new machinery will be $160000 per year. The addition in costs as an outcome from the new machinery on account of use of direct labour and materials, transportation, extra expense charges, constructing rent related with the new machinery would amount to $90000 every year. Marginal income tax for the industries is 20%. You are required to determine the following: 1. Compute the Net Cash Flow using straight line method of depreciation 2. Using IRR - Internal Rate of Return method, should the new investment project be acknowledged or eliminated if the cost of capital comes about 6% per annum. Q.5:- ABC is considering a proposal to enter a new line of business. In reviewing the proposal, the company’s CFO is considering the following facts: The new business will require the company to purchase additional fixed assets that will cost $600,000 at t=0 For tax and accounting purposes, these costs will be depreciated on a straight-line basis over three years (annual deprec. = 200,000). At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100,000 The project will require a $50,000 increase in NOWC at t = 0, which will be recovered at t = 3.The company’s marginal tax rate is 35%. The new business is expected to generate $2 million in sales each year (at t = 1, 2 and 3).

The operating costs excluding depreciation are expected to be $1.4 million per year. The project’s cost of capital is 12%. What is the project’s NPV? Q.6:- A firm has a proposed 5-year project. If accepted today (t=0), the project isexpected to generate positive net cash flows for each of the following five years(t=1 through t=5). A new machine will be put in service, and to implement thisproject, an old machine will be sold. Note the following items. The new machine costs $1,000,000. Shipping and installation will cost anadditional $500,000. Thus the Installed Cost is $1,500,000.This new machine will be sold five years from today when this project iscompleted. We believe that it can be sold for $100,000 in five years. If this project is accepted, then an old, fully depreciated, machine will bereplaced. The old machine can be sold for $50,000 today. The Installed Cost of this new asset will be depreciated using the IRS 5-year MACRS schedule: year 1, 20%; year 2, 32%; year 3, 19.2%; year 4, 11.52%; year5, 11.52%; and year 6, 5.76%. Note that these yearly amounts sum to 100%. The project will increase revenues and operating expenses (before depreciationand amortization) by $800,000 and $300,000 per year, respectively, for each of thefollowing five years (t=1 to t=5). An initial increase in Net Working Capital of $50,000 is required today and thisamount will be recovered in 5 years when the project is terminated. No otherchanges in NWC will be required during the project’s life.The cost of capital of the project is r=11%. The corporate income tax rate is 40%. You are required to determine the following: a) Compute the relevant cash flows b) Compute the NPV, IRR , Payback period and profitability index to decide whether a firm should start this project or not.

c)...