retsolns - Measuring Investment Returns: Solutions Problem...

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Measuring Investment Returns: Solutions Problem 1 Year Beginning BV Depreciation Ending BV Average BV Revenues COGS EBIT EBIT (1-t) 1 25 3 22 23.5 20.00 $ 10.00 $ 7.00 $ 4.20 $ 2 22 3 19 20.5 22.00 $ 11.00 $ 8.00 $ 4.80 $ 3 19 3 16 17.5 24.20 $ 12.10 $ 9.10 $ 5.46 $ 4 16 3 13 14.5 26.62 $ 13.31 $ 10.31 $ 6.19 $ 5 13 3 10 11.5 29.28 $ 14.64 $ 11.64 $ 6.98 $ a. Pre-tax Return on Capital Year Average BV EBIT Pre-tax ROC 1 23.5 7.00 $ 29.79% 2 20.5 8.00 $ 39.02% 3 17.5 9.10 $ 52.00% 4 14.5 10.31 $ 71.10% 5 11.5 11.64 $ 101.23% Average 58.63% b. Year Average BV EBIT (1-t) After-tax ROC 1 23.5 4.20 $ 17.87% 2 20.5 4.80 $ 23.41% 3 17.5 5.46 $ 31.20% 4 14.5 6.19 $ 42.66% 5 11.5 6.98 $ 60.74% Average 35.18% c. Since the return on capital is greater than the cost of capital, I would accept the project. Problem 2 Year Beginning BV Depreciation Ending BV Average BV Revenues COGS EBIT EBIT (1-t) 1 25.00 $ 6.00 $ 19.00 $ 22.00 $ 20.00 $ 10.00 $ 4.00 $ 2.40 $ 2 19.00 $ 3.60 $ 15.40 $ 17.20 $ 22.00 $ 11.00 $ 7.40 $ 4.44 $ 3 15.40 $ 2.16 $ 13.24 $ 14.32 $ 24.20 $ 12.10 $ 9.94 $ 5.96 $ 4 13.24 $ 2.00 $ 11.25 $ 12.24 $ 26.62 $ 13.31 $ 11.32 $ 6.79 $ 5 11.25 $ 2.00 $ 9.25 $ 10.25 $ 29.28 $ 14.64 $ 12.65 $ 7.59 $ a. Pre-tax Return on Capital Year Average BV EBIT Pre-tax ROC 1 22.00 $ 4.00 $ 18.18% 2 17.20 $ 7.40 $ 43.02% 3 14.32 $ 9.94 $ 69.41% 4 12.24 $ 11.32 $ 92.42% Page 1
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Measuring Investment Returns: Solutions 5 10.25 $ 12.65 $ 123.41% Average 69.29% b. Year Average BV EBIT (1-t) After-tax ROC 1 22.00 $ 2.40 $ 10.91% 2 17.20 $ 4.44 $ 25.81% 3 14.32 $ 5.96 $ 41.65% 4 12.24 $ 6.79 $ 55.45% 5 10.25 $ 7.59 $ 74.04% Average 41.57% c. Since the return on capital is greater than the cost of capital, I would accept the project. Problem 3 Year Beg BV Equity Depreciation End BV Equity Avg BV Equity Revenues COGS Int Exp Taxable Inc. Net Income 1 15.00 $ 3.00 $ 12.00 $ 13.50 $ 20.00 $ 10.00 $ 1.00 $ 6.00 $ 3.60 $ 2 12.00 $ 3.00 $ 9.00 $ 10.50 $ 22.00 $ 11.00 $ 1.00 $ 7.00 $ 4.20 $ 3 9.00 $ 3.00 $ 6.00 $ 7.50 $ 24.20 $ 12.10 $ 1.00 $ 8.10 $ 4.86 $ 4 6.00 $ 3.00 $ 3.00 $ 4.50 $ 26.62 $ 13.31 $ 1.00 $ 9.31 $ 5.59 $ 5 3.00 $ 3.00 $ - $ 1.50 $ 29.28 $ 14.64 $ 1.00 $ 10.64 $ 6.38 $ a. Year Avge BV Equity Net Income ROE 1 13.5 3.60 $ 26.67% 2 10.5 4.20 $ 40.00% 3 7.5 4.86 $ 64.80% 4 4.5 5.59 $ 124.13% 5 1.5 6.38 $ 425.64% Average 136.25% b. Since the return on equity is greater than the cost of equity, I would accept the project. Problem 4 a. False. This is true only if the project makes a return higher than the after-tax cost of borrowing. b. False. The comparison should be to the cost of capital. c. False. The book value of equity will also be lower. d. False. It will lower earnings and returns. e. True. It will accentuate the increase in return on equity as the project ages. Problem 5 This will occur only if Page 2
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Measuring Investment Returns: Solutions 1. earnings are equal to cash flows to equity, i.e., there are no non-cash charges, working capital or cap ex. 2. earnings are level over time. Problem 6 Year 0 1 2 3 4 Investment 15000 2000 WC Investment 1000 Salvage 7000 ! Book value is salvaged Revenues 10,000 $ 11,000 $ 12,000 $ 13,000 $ - COGS 4,000 $ 4,400 $ 4,800 $ 5,200 $ - Deprec'n 4,000 $ 3,000 $ 2,000 $ 1,000 $ EBIT 2,000 $ 3,600 $ 5,200 $ 6,800 $ EBIT (1-t) 1,200 $ 2,160 $ 3,120 $ 4,080 $ + Deprec'n 4,000 $ 3,000 $ 2,000 $ 1,000 $ - Chg in WC 100 $ 100 $ 100 $ (1,300) $ FCFF (16,000) $ 5,100 $ 3,060 $ 5,020 $ 13,380 $ a. See above b. Payback Cumulated FCFF (16,000) $ (10,900) $ (7,840) $ (2,820) $ 10,560 $ Pauback is early in the fourth year. c. NPV of Project at 12% cost of capital PV of Cash flow (16,000) $ 4,554 $ 2,439 $ 3,573 $ 8,503 $ NPV of Project = 3,069.35 $ d. IRR of Project 19.26% Problem 7 Year 0 1 2 3 4 Investment 15000 2000 WC Investment 1000 - Debt Issued 6400 800 + Salvage 7000 Revenues 10,000 $ 11,000 $ 12,000 $ 13,000 $ - COGS 4,000 $ 4,400 $ 4,800 $ 5,200 $ - Deprec'n 4,000 $ 3,000 $ 2,000 $ 1,000 $ - Interest Exp. 640 $ 644 $ 728 $ 732 $ Taxable Inc. 1,360 $ 2,956 $ 4,472 $ 6,068 $ Net Income 816 $ 1,774 $ 2,683 $ 3,641 $ + Deprec'n 4,000 $ 3,000 $ 2,000 $ 1,000 $ - Chg in WC 100 $ 100 $ 100 $ (1,300) $ + new Debt Issued 40 $ 40 $ 40 $ Page 3
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Measuring Investment Returns: Solutions - Principal Repaid 7,320 $ FCFE (9,600) $ 4,756 $ 3,514 $ 4,623 $ 5,621 $ a. See above b. Payback Cum. FCFE (9,600) $ (4,844) $ (1,330) $ 3,293 $ 8,914 $ Payback is shortly after the end of the second year c. NPV PV at 16% (9,600.0) $ 4,100.00 $ 2,611.18 $ 2,961.89 $ 3,104.32 $ NPV = 3,177.38 $ Problem 8 Year FCFF 0 (10,000,000) $ 1 4,000,000 $ 2 5,000,000 $ 3 6,000,000 $ Discount Rate NPV 2% $4,381,347 4% $3,802,913 6% $3,261,283 8% $2,753,391 10% $2,276,484 12% $1,828,079 14% $1,405,939 16% $1,008,036 18% $632,538 20% $277,778 22% ($57,758) 24% ($375,449) 26% ($676,553) 28% ($962,219) 30% ($1,233,500) The internal rate of return ofthis project is about 215. I would accept the project because its return is greater
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This note was uploaded on 01/29/2012 for the course ECONOMICS 3400 taught by Professor Kroger during the Spring '11 term at Georgia State University, Atlanta.

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retsolns - Measuring Investment Returns: Solutions Problem...

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