1)You are considering a project that will cost you $16,000,000 initially. Your cost of capital for this project is 8%. There is a 80% probability that the project will generate cash flows of $2,000,000 per year in perpetuity, and a 20% probability that the project will generate cash flows of $500,000 per year in perpetuity. If you could sell the project at the end of the first year for $6,950,724, what is the value of this abandonment option today? 2)Your firm has weights of debt (wD) and equity (wS) of 0.25 and 0.75, respectively. The cost of debt (rD) is 6% per year and the cost of equity (rS) is 17% per year. What is your firm's pre-tax Weighted Average Cost of Capital (WACC)? 3)You are a subcontractor bidding on a contract to provide car batteries to be sold at WalMart stores throughout Ohio for three years. You wish to enter a bid price that makes your NPV exactly $0. You have completed Steps 1-3 of the process explained at the end of the Chapter 11 slides and you find that you need to generate an annual OCF of $275,587.20 to get exactly NPV=0. Solve for the price per battery that you need to charge using the following information: Quantity: 11,226 batteries per year Variable costs: $37 per battery Fixed costs: $585,000 per year Tax rate: 21% Depreciation: $200,000 per year 4) A firm just issued bonds at par with a market value of $251 million. This will be permanent debt. The cost of debt, rD, is 10.07%. The firm's tax rate is 21%. What is the present value of the interest tax shield, PV(ITS)? Assume that rD is also the appropriate discount rate for the cash flows.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 4P

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1)You are considering a project that will cost you $16,000,000 initially. Your cost of capital for this project is 8%. There is a 80% probability that the project will generate cash flows of $2,000,000 per year in perpetuity, and a 20% probability that the project will generate cash flows of $500,000 per year in perpetuity. If you could sell the project at the end of the first year for $6,950,724, what is the value of this abandonment option today?

2)Your firm has weights of debt (wD) and equity (wS) of 0.25 and 0.75, respectively. The cost of debt (rD) is 6% per year and the cost of equity (rS) is 17% per year. What is your firm's pre-tax Weighted Average Cost of Capital (WACC)?

3)You are a subcontractor bidding on a contract to provide car batteries to be sold at WalMart stores throughout Ohio for three years. You wish to enter a bid price that makes your NPV exactly $0. You have completed Steps 1-3 of the process explained at the end of the Chapter 11 slides and you find that you need to generate an annual OCF of $275,587.20 to get exactly NPV=0. Solve for the price per battery that you need to charge using the following information:

Quantity: 11,226 batteries per year

Variable costs: $37 per battery

Fixed costs: $585,000 per year

Tax rate: 21%

Depreciation: $200,000 per year

4) A firm just issued bonds at par with a market value of $251 million. This will be permanent debt. The cost of debt, rD, is 10.07%. The firm's tax rate is 21%. What is the present value of the interest tax shield, PV(ITS)? Assume that rD is also the appropriate discount rate for the cash flows.

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