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Let X denote the number of shares to be sold. The total flotation cost would be
(0.06)($25) X $1.5 X
25 X 1.5 X $10,000,000
23.5 X $10,000,000
X 425,532 shares
Flotation cost = $1.5(425,532) = $638,298
12.2 *
(a) Equal repayment of the principal:
Repayment
n Loan Balance
Interest Principal
0 $300,000
1 $36,000 $50,000 $250,000
2 $30,000 $50,000 $200,000
3 $24,000 $50,000 $150,000
4 $18,000 $50,000 $100,000
5 $12,000 $50,000 $50,000
6 $6,000 $50,000 $0
*
An asterisk next to a problem number indicates that the solution is available to students
on the Companion Website.
Interest Principal
0 $300,000
1 $36,000 $0 $300,000
2 $36,000 $0 $300,000
3 $36,000 $0 $300,000
4 $36,000 $0 $300,000
5 $36,000 $0 $300,000
6 $36,000 $300,000 $0
Repayment
n Loan Balance
Interest Principal
0 $300,000
1 $36,000 $36,968 $263,032
2 $31,564 $41,404 $221,628
3 $26,595 $46,372 $175,256
4 $21,031 $51,937 $123,319
5 $14,798 $58,169 $65,150
6 $7,818 $65,150 $0
12.3
(a) Equity financing
End of Year 0 1 2 3 4
Income Statement
Revenues/Savings $100,000 $100,000 $100,000 $100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Taxable income 70,000 49,000 64,300 75,010
Income taxes (35%) 24,500 17,150 22,505 26,254
Net Income $45,500 $31,850 $41,795 $48,757
PW(10%) = $72,958
AE(10%) = $23,016
End of Year 0 1 2 3 4
Income Statement (Bank
A)
Revenues/Savings $100,000 $100,000 $100,000 $100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Interest (10%) 20,000 15,000 10,000 5,000
Taxable income 50,000 34,000 54,300 70,010
Income taxes (35%) 17,500 11,900 19,005 24,504
Net Income $32,500 $22,100 $35,295 $45,507
PW(10%) = $87,486
AE(10%) = $27,599
End of Year 0 1 2 3 4 5
Income Statement
Revenues/Savings $100,000 $100,000 $100,000 $100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Interest (10%) 20,000 16,724 13,121 9,157 4,796
Taxable income 50,000 32,276 51,179 65,853 (4,796)
Income taxes (35%) 17,500 11,297 17,913 23,049 (1,679)
Net Income $32,500 $20,979 $33,267 $42,805 (3,118)
PW(10%) = $90,841
AE(10%) = $28,658
Comments: The project terminates after four years where the bank financing from
Bank B extends over five years. Since the bank financing is related to the proposed
project, any unpaid future expenses after the project must be charged against the
revenue from the proposed project. This adjustment is shown under the
prepayment in the amount of $46,437, which is the equivalent cost in year 4 for
the future expense (net cash flow) in the amount of $51,081 at the firms MARR.
12.4
(a) The total flotation costs to raise $65 million:
Common stock:
Amount of common stock ($65, 000, 000)(0.45)
$29, 250, 000
$29, 250, 000
Flotation cost = $29, 250, 000 $1, 410,377
1 0.046
Preferred stock:
Amount of preferred stock ($65, 000, 000)(0.10)
$6,500, 000
$6,500, 000
Flotation cost = $6,500, 000 $572,905
1 0.081
Bond:
Amount of bond ($65, 000, 000)(0.45)
$29, 250, 000
$29, 250, 000
Flotation cost = $29, 250, 000 $425,314
1 0.014
Common stock:
X S (1 0.046)($32) $29, 250, 000
X S 958,137 shares
Preferred stock:
X P (1 0.081)($55) $6,500, 000
X P 128,598 shares
Bond:
X B (1 0.014)($980) $29, 250, 000
X B 30, 271 units
Bond:
Borrowing amount (30, 271)($1, 000)
$30, 271, 000
Annual interest = ($30,271,000)(0.12) = $3,632,520
Cost of Capital
12.5 After-tax cost of debt:
(a)
(0.12)(1 0.25) 0.09 or 9%
(b)
(0.14)(1 0.34) 0.0924 or 9.24%
(c)
(0.15)(1 0.40) 0.09 or 9%
12.6 In the absence of bond maturity date, we need to assume that the 13% yield to
maturity represents the before-tax cost of debt after considering both the
flotation cost as well as bond discounting. Let kb 13% . Then we compute the
after-tax cost of debt as follows:
$1
kr 0.12 17.56%
$18
12.8
(a) Flotation costs in percentage:
15
fc 1 16.67%
18
12.9
ie 0.22
id (0.13)(1 0.40) 0.078
k (0.078)(0.45) (0.22)(0.55)
0.1561
*
12.11
Given: ie 18%, id (0.12)(1 0.36) 0.0768
(a) Net equity flow method: PW (18%) $36,306 0 , accept the project.
End of Year 0 1 2 3 4 5
Income Statement
Revenue $90,000 $90,000 $90,000 $90,000 $90,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000
Interest payment 9,600 8,089 6,396 4,501 2,378
CCA 30,000 51,000 35,700 24,990 17,493
Taxable income 40,400 20,911 37,904 50,509 60,129
Income taxes (36%) 14,544 7,528 13,645 18,183 21,647
Net Income $25,856 $13,383 $24,258 $32,326 $38,483
(b) Cost of capital method: PW (13.87%) $41, 704 0 , accept the project.
End of Year 0 1 2 3 4 5
Income Statement
Revenue $90,000 $90,000 $90,000 $90,000 $90,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000
CCA 30,000 51,000 35,700 24,990 17,493
Taxable income 50,000 29,000 44,300 55,010 62,507
Income taxes (36%) 18,000 10,440 15,948 19,804 22,503
Net Income $32,000 $18,560 $28,352 $35,206 $40,004
12.12
(a) Net equity flow method:
End of Year 0 1 2 3 4 5
Income Statement
Revenue $45,000 $45,000 $45,000 $45,000 $45,000
Expenses
Interest payment 9,000 7,665 6,130 4,365 2,335
CCA 15,000 25,500 17,850 12,495 8,747
Taxable income 21,000 11,835 21,020 28,140 33,919
Income taxes (30%) 6,300 3,550 6,306 8,442 10,176
Net Income $14,700 $8,284 $14,714 $19,698 $23,743
End of Year 0 1 2 3 4 5
Income Statement
Revenue $45,000 $45,000 $45,000 $45,000 $45,000
Expenses
CCA 15,000 25,500 17,850 12,495 8,747
Taxable income 30,000 19,500 27,150 32,505 36,254
Income taxes (30%) 9,000 5,850 8,145 9,752 10,876
Net Income $21,000 $13,650 $19,005 $22,754 $25,377
Operating activities
Net income $21,000 $13,650 $19,005 $22,754 $25,377
CCA 15,000 25,500 17,850 12,495 8,747
Investment and Salvage (100,000) 30,000
Disposal tax effects (2,877)
Net cash flow ($100,000) $36,000 $39,150 $36,855 $35,249 $61,247
PW 14.3% $38,189
12.13
(a) Using ie 15% : Select Machine B.
Machine A
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Expenses
O&M 8,000 8,000 8,000 8,000 8,000 8,000
Interest payment 1,200 1,044 873 685 478 250
CCA $6,000 $10,200 $7,140 $4,998 $3,499 $2,449
Taxable income 4,800 756 3,987 6,317 8,023 9,300
Income taxes (35%) 1,680 264 1,395 2,211 2,808 3,255
Net Income $3,120 $491 $2,591 $4,106 $5,215 $6,045
PW(15%) = $2,329
Machine B
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue $28,000 $28,000 $28,000 $28,000 $28,000 $28,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000 10,000
PW(15%) = $4,056
(b) Using k 0.31 0.35 0.1 0.7 0.15 12.45% : Select machine B.
Machine A
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Expenses
O&M 8,000 8,000 8,000 8,000 8,000 8,000
CCA $6,000 $10,200 $7,140 $4,998 $3,499 $2,449
Taxable income 6,000 1,800 4,860 7,002 8,501 9,551
Income taxes (35%) 2,100 630 1,701 2,451 2,975 3,343
Net Income $3,900 $1,170 $3,159 $4,551 $5,526 $6,208
PW(12.45%) = $2,587
Machine B
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue $28,000 $28,000 $28,000 $28,000 $28,000 $28,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000 10,000
CCA $9,000 $15,300 $10,710 $7,497 $5,248 $3,674
Taxable income 9,000 2,700 7,290 10,503 12,752 14,326
Income taxes (35%) 3,150 945 2,552 3,676 4,463 5,014
Net Income $5,850 $1,755 $4,739 $6,827 $8,289 $9,312
PW(12.45%) = $4,523
Capital Budgeting
12.14 Based on the investment opportunity curve below, the firms optimal capital
budget would be $177 million, with no restriction on the firms debt limit.
However, with a budget limit of $100 million, the firm may select Projects 5
and 3 first. Since these two projects alone consume $95 million, the firm may
have two choices about utilizing the remaining $5 million funds. First choice is
to find any projects whose rates of return exceed the cost of capital. Project 4
comes close to meeting this requirement. However, the firms borrowing rate is
18%, which is greater than the rate of return from Project 4. Therefore, the
projects that should be included in the $100 million budget would be Projects 5
and 3. If money has to be raised from outside, the firm should raise only $95
million.
Rate of Return
90%
5 80%
3
40%
2 32% 30%
7 6 22%
1 15% Borrowing rate (18%)
4
Lending (12%)
12.15
(a) Present worth analysis: With no budget restriction, select alternatives 1, 2, 3, 4,
7, 13, and 14. The total NPW from the projects is $2,194.
j PW(8%) j PW(8%)
1 $303 8 -$208
2 $500 9 -$165
3 $661 10 -$27
4 $46 11 -$1,017
5 -$66 12 -$248
6 -$814 13 $126
7 $47 14 $512
(b) With a budget limit of $1,800, select alternatives 1, 2, 3, 4, 13, and 14. The
total amount of investment required is $1,756.
$2,100, 000
1 0.4
$3,500, 000
(c)
MARR with known source of financing = Cost of equity
Increase in share price over the four years plus the dividends each year, divided
by the starting share price:
1
(18 8) 1.1 1.2 1.5 1.9 4
ie 1 18.36%
8
(d) Assuming that the company funds the new project by maintaining the same
debt to equity ratio. To raise the $10,080,00 needed (for equipment and
installation), they have to borrow $4,032,000 and issue 336,000 stocks (at $18
per share), which will increase their equity $6,048,000 for the project. At 11%,
the flotation costs of $665,280 are deducted as an expense.
End of Year 0 1 2
Income Statement
Revenue $44,000,000 $44,000,000
Cost of Goods Sold 35,200,000 26,400,000
Interest 403,200 403,200
CCA $1,512,000 $2,570,400
Taxable income 6,884,800 14,626,400
Income taxes (40%) 2,753,920 5,850,560
Net Income $4,130,880 $8,775,840
(e) Three different ways to finance the project are considered. In case of debt
financing, the interests are at the end of each year and the principal is fully
repaid in a lump sum at the end of the fifth year. Based on the analyses, the
potential stock price of each case would be as follows:
ST 12.2
(a) There are 36 mutually exclusive alternatives without considering the budget
and engineering-hour constraints. Projects 1 and 2 are mutually exclusive
projects; Projects 5 and 6 or keeping the current supplier are mutually
exclusive; Project 3 is contingent on Project 2.
(b) There are 10 feasible alternatives with the budget and time restrictions:
1 1 6 2,6
2 2 7 2,7
3 1,4 8 1,4,7
4 1,5 9 1,5,7
5 1,7 10 2,6,7
(c) Without knowing the exact cash flow sequences for each project over the
project life, it is not feasible to determine the optimal capital budget.
ST 12.3
(a) Select A and C with FW(10%) = $4,894. Since $500 is left over after selecting
A and C, we could lend out the leftover funds at 10% for three periods.
Therefore, the total amount available for lending at the end of period 3 is
calculated as follows:
F $4,894 $500( F / P,10%,3)
$5,559.60
(b) Select B and C. The total amount available for lending at the end of period 3 is
$5,740.
(c) With a budget limit of $3,500, the reasonable MARR should be the lending
rate of 10%. (You select A and C and have $500 available for lending.)
ST 12.4
(a) The debt repayment schedule for the loan from the equipment manufacturer:
Loan Repayment
n Loan Balance
Interest Principal
0 $2,000,000
1 $200,000 $125,491 $1,874,509
2 $187,451 $138,040 $1,736,469
$8,500, 000
Flotation cost = $8,500, 000 $749,184
1 0.081
$8,500, 000
Number of shares = 205,537 shares
(1 0.081)($45)
(c) The flotation costs and the number of $1,000 bonds to raise $10.5 million:
$10,500, 000
Flotation cost = $10,500, 000 $203,364
1 0.019
$10,500, 000
Number of bonds = 11,893units
(1 0.019)($900)
ST 12.5 (a) The net cash flow from the cogeneration project with bond financing
End of Year 0 1 2 3 4 5 6 7 8 9 10 11 12
(all units in thousands of dollars)
Income Statement
Revenue
Electricity bill $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0
Excess power 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0
Expenses
O&M 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0
Misc. 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0
Standby Power 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4
Fuel 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0
Overhauls 1,600.0 1,600.0 1,600.0
CCA on Unit 500.0 950.0 855.0 769.5 692.6 623.3 561.0 504.9 454.4 408.9 368.0 331.2
CCA on Inter. Equip. 75.0 127.5 89.3 62.5 43.7 30.6 21.4 15.0 10.5 7.4 5.1 3.6
Interest (9%) 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4
Taxable income 2,168.23 1,665.73 198.98 1,911.26 2,006.95 489.32 2,160.84 2,223.36 678.35 2,326.94 2,370.04 2,408.38
Income taxes (36%) 780.56 599.66 71.63 688.05 722.50 176.16 777.90 800.41 244.21 837.70 853.21 867.02
Net Income 1,387.67 1,066.07 127.35 1,223.20 1,284.45 313.17 1,382.93 1,422.95 434.14 1,489.24 1,516.82 1,541.37
End of Year 0 1 2 3 4 5 6 7 8 9 10 11 12
(all units in thousands of dollars)
Income Statement
Revenue
Electricity bill $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0 $6,120.0
Excess power 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0
Expenses
O&M 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0
Misc. 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0
Standby Power 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4
Fuel 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0
Overhauls 1,600.0 1,600.0 1,600.0
Lease 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5
Taxable income 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 2,904.07
Income taxes (36%) 1,045.47 1,045.47 469.47 1,045.47 1,045.47 469.47 1,045.47 1,045.47 469.47 1,045.47 1,045.47 1,045.47
Net Income 1,858.61 1,858.61 834.61 1,858.61 1,858.61 834.61 1,858.61 1,858.61 834.61 1,858.61 1,858.61 1,858.61