Week 6 Supplemental Problem Solutions

Dinshaw Company is considering the purchase of a new machine. The invoice price of the machine is $87,306, freight charges are estimated to be $2,620, and installation costs are expected to be $7,370. The annual cost savings are expected to be $14,980 for 11 years. The firm requires a 20% rate of return. Ignore income taxes. What is the internal rate of return on this investment? Internal rate of return % Round to 0 decimal placese

What is the firm's degree of leverage?

1. You possess a small manufacturing facility making $2 million annually. Depending on a long-term government contract decision, next year, your revenue could either rise by 20% or drop by 25%, both outcomes having an equal chance, and maintaining that level for the plant's operational duration. Additional costs tally up to $1.6 million per year. You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%. a. If the government does not award you the contract and your sales decrease by 25%, what will be the value of your plant? b. Given the embedded option to sell the plant, compute the value of the plant. c. Suppose that you are not able to sell the plant, but you can shut it down at any time at no cost. What is the value of the option to abandon production? | d. Companies sometimes proceed with capital projects despite their negative NPV. Critically discuss what drives this decision.

You run a perpetual encabulator machine, which generates revenues averaging $20 million per year. Raw material costs are 50% of revenues. These costs are variable-they are always proportional to revenues. There are no other operating costs. The cost of capital is 9%. Your firm's long-term borrowing rate is 6%. Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $10 million per year for 10 years. a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract? Operating leverage and business risk increases Operating leverage and business risk decreases b. Calculate the present value of the encabulator machine with and without the fixed-price contract. (Do not round intermediate calculations. Enter your answers in dollars not in millions. Round your answers to the nearest whole dollar amount.) With contract Without contract $ Present Value 101,686,818

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What is the firm's degree of leverage?

Assume a machine costs $250,000 and lasts five years before it is replaced. The operating cost is $37,200 a year. Ignore taxes. What is the equivalent annual cost if the required rate of return is 8.5 percent? (Hint: the EAC should account for both investment and annual operating costs) O $124,166.76 O $118,285.43 O $112,404.10 O$106,522.77 $100,641.44

Your company is analyzing purchase of a machine costing $5,900 today. The investment promises to add $18,500 to sales one year from today, $14,500 two years from today, and $18,000 three years from today. Incremental cash costs should consume 75% of the incremental sales. The tax rate is 30% and the company’s financing rate is 8.2%. The investment cost is depreciated to zero over a 3-year straight-line schedule. What is the IRR for the project?

A proposed project has fixed costs of $88,000 per year. The operating cash flow at 11,300 units is $116,500. Ignore the effect of taxes. What is the degree of operating leverage?

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9

The X Division of NUBD Products Co. is considering an investment in a new project.  The project has an estimated cost of P1,000,000.  If NUBD Products Co. has a target rate of return of 12%, how large does the return on investment on this project need to be to generate P180,000 of residual income?

NPV. Grady Precision Measurement Tools has forecasted the following sales and costs for a new GPS system: annual sales of 46,000 units at $17 a unit, production costs at 37% of sales price, annual fixed costs for production at $200,000. The company tax rate is 40%. What is the annual operating cash flow of the new GPS system? Should Grady Precision Measurement Tools add the GPS system to its set of products? The initial investment is $1,400,000 for manufacturing equipment, which will be depreciated over six years (straight line) and will be sold at the end of five years for $380,000. The cost of capital is 10%. What is the annual operating cash flow of the new GPS system? (Round to the nearest dollar.)

If we consider the effect of taxes, then the degree of operating leverage can be written as:   DOL = 1 + [FC × (1 – TC) – TC × D]/OCF   Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3.1 million investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $925,000 and that variable costs should be $185 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $400,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $295 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. The tax rate is 22 percent.     a. What is the DOL at the base-case…

A proposed project has fixed costs of $35,000 per year. The operating cash flow at 14,000 units is $60,000. a. Ignoring the effect of taxes, what is the degree of operating leverage? b. If units sold rise from 14,000 to 14,400, what will be the increase in operating cash flow? c. What is the new degree of operating leverage?