BU393_Final_Exam_Practice_Problems - BU393 Spring 2005...

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BU393 Spring 2005 Final Review Questions (solutions at the end) BU 393 1. James Silverman owns 60 shares of NW Trading Company and has $750 in cash for new investment. The company has offered a rights issue in which purchasing a new share would require four rights plus $50 in cash. Current market value of one share is $62. a. What is the value of one right? b. Show that Silverman’s wealth is unaffected by the rights issue if he exercises the rights. 2. Excellent Enterprises considers investing in a new machine that would cost $100,000 and is expected to produce before tax savings of $33,333 per year for 10 years, at which point the machine could be sold for $4500. CCA on a declining balance can be taken at a rate of 30%. The company’s opportunity cost of capital is 12% and it’s tax rate is 40%. a. Based on the project’s NPV should the firm proceed? b. A more careful forecast is prepared by the divisional manager to include possible variations in cash flows. It is possible that sales could vary, decreasing before tax savings by up to $15,000 a year . Once sales patterns are established in the first year they are expected to remain at this level over the life of the machine. Also it is possible that the new machine may last up to 12 years not 10 as originally forecast, and then it could be sold for $4500. What is the range of NPV that this project could realistically generate? c. Suppose the firm is unsure about the true salvage value of the machine. Given the original estimates of operating savings and project lifetime, what is the minimum salvage value for which this project is still profitable? 3. Hanson Technology is considering 2 projects: Year Project A Cash Flow (After tax) Project B Cash Flow (After tax) 1 $4000 $1500 2 $3000 $4800 3 $2000 $3200 Project A requires an investment of $6861. Project B requires an investment of $6665.70 a. Calculate the payback, discounted payback, IRR and NPV for both projects if Hanson’s discount rate is 14%. b. Assume these projects are independent and the firm’s maximum payback period is 2. Based on your answers above, should Hanson select project A only, project B only or both? 1
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BU393 Spring 2005 c. Assume these projects are mutually exclusive. What should Hanson do? Why? 4. A firm is considering undertaking a new project whose risk matches the risk of the firm. Retained earnings are insufficient to finance the new project, and so the firm is considering public issues of debt, common and preferred shares. To match the current capital structure the firm finances new projects by 50% debt, 40% common shares and 10% preferred shares. A firm can issue 10 year bonds with an annual coupon rate of 9%, but only if they are sold at a discount of 2%, or at 97.5% of face value. Underwriting expenses amount to a further 2.5% of face value. Preferred shares, with $25 par value can be issued to net 90% of par value after expenses, carry a dividend of $2.00. The firm’s common shares currently trade at $30, and a
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This note was uploaded on 10/15/2011 for the course BUSINESS bu393 taught by Professor - during the Spring '11 term at Wilfred Laurier University .

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BU393_Final_Exam_Practice_Problems - BU393 Spring 2005...

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