Chapter 10

The Basics of Capital Budgeting

SOLUTIONS TO END-OF-CHAPTER PROBLEMS
10-1

a. $52,125/$12,000 = 4.3438, so the payback is about 4 years.

b. Project K's discounted payback period is calculated as follows:
Annual
Period Cash Flows
0
($52,125)
1
12,000
2
12,000
3
12,000
4
12,000
5
12,000
6
12,000
7
12,000
8
12,000

Discounted @12%
Cash Flows
($52,125.00)
10,714.80
9,566.40
8,541.60
7,626.00
6,808.80
6,079.20
5,427.60
4,846.80

The discounted payback period is 6 +

Cumulative
($52,125.00)
(41,410.20)
(31,843.80)
(23,302.20)
(15,676.20)
(8,867.40)
(2,788.20)
2,639.40
7,486.20

$2,788.20
years, or 6.51 years.
$5,427.60

Alternatively, since the annual cash flows are the same, one can divide $12,000 by 1.12
(the discount rate = 12%) to arrive at CF1 and then continue to divide by 1.12 seven more
times to obtain the discounted cash flows (Column 3 values). The remainder of the
analysis would be the same.
c. NPV = -$52,125 + $12,000[(1/i)-(1/(i*(1+i)n)]
= -$52,125 + $12,000[(1/0.12)-(1/(0.12*(1+0.12)8)]
= -$52,125 + $12,000(4.9676) = $7,486.20.
Financial calculator: Input the appropriate cash flows into the cash flow register, input I
= 12, and then solve for NPV = $7,486.68.
d. Financial calculator: Input the appropriate cash flows into the cash flow register and
then solve for IRR = 16%.

e. MIRR: PV Costs = $52,125.

FV Inflows:
PV
0 12% 1
|

12,000

52,125

FV
8

12,000 12,000 12,000 12,000 12,000 12,000 12,000

13,440
15,053
16,859
18,882
21,148
23,686
26,528
MIRR = 13.89%
147,596

Financial calculator: Obtain the FVA by inputting N = 8, I = 12, PV = 0, PMT = 12000,

and then solve for FV = $147,596. The MIRR can be obtained by inputting N = 8,
PV = -52125, PMT = 0, FV = 147596, and then solving for I = 13.89%.
10-3

Truck:
NPV = -$17,100 + $5,100(PVIFA14%,5)
= -$17,100 + $5,100(3.4331) = -$17,100 + $17,509
= $409.
(Accept)
Financial calculator: Input the appropriate cash flows into the cash flow register, input I
= 14, and then solve for NPV = $409.
Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 14.99% 15%.
MIRR: PV Costs = $17,100.

FV Inflows:
PV
0 14%
|

5,100

17,100

5,100

5,100

5,100

MIRR = 14.54% (Accept)

FV
5
|

5,100
5,814
6,628
7,556
8,614
33,712

Financial calculator: Obtain the FVA by inputting N = 5, I = 14, PV = 0, PMT = 5100,

and then solve for FV = $33,712. The MIRR can be obtained by inputting N = 5, PV = 17100, PMT = 0, FV = 33712, and then solving for I = 14.54%.
Pulley:
NPV = -$22,430 + $7,500(3.4331) = -$22,430 + $25,748
= $3,318.
(Accept)
Financial calculator: Input the appropriate cash flows into the cash flow register, input I
= 14, and then solve for NPV = $3,318.
Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 20%.
MIRR: PV Costs = $22,430.
FV Inflows:
PV
0
|

14%

1
|

7,500

22,430

2
|

7,500

3
|

7,500

MIRR = 17.19% (Accept)

4
|

7,500

FV
5
|

7,500
8,550
9,747
11,112
12,667
49,576

Financial calculator: Obtain the FVA by inputting N = 5, I = 14, PV = 0, PMT = 7500,

and then solve for FV = $49,576. The MIRR can be obtained by inputting N = 5, PV = 22430, PMT = 0, FV = 49576, and then solving for I = 17.19%.

10-16 a. Using a financial calculator, input the following: CF0 = -190000, CF1 = 87000, Nj =
3, and I = 14 to solve for NPV190-3 = $11,981.99 $11,982 (for 3 years).
Adjusted NPV190-3 = $11,982 + $11,982/(1.14)3 = $20,070.
Using a financial calculator, input the following: CF0 = -360000, CF1 = 98300, Nj =
6, and I = 14 to solve for NPV360-6 = $22,256.02 $22,256 (for 6 years).
Both new machines have positive NPVs, hence the old machine should be
replaced. Further, since its adjusted NPV is greater, choose Model 360-6.

Chapter 11
Cash Flow Estimation and Risk Analysis
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
11-4

a. The net cost is $126,000:

Price
($108,000)
Modification
(12,500)
Increase in NWC
(5,500)
Cash outlay for new machine ($126,000)
b. The operating cash flows follow:
Year 1 Year 2 Year 3
1. After-tax savings
$28,600 $28,600 $28,600
2. Depreciation tax savings
13,918 18,979
6,326
Net cash flow
$42,518 $47,579 $34,926
Notes:
1. The after-tax cost savings is $44,000(1 - T) = $44,000(0.65)
= $28,600.
2. The depreciation expense in each year is the depreciable basis, $120,500, times
the MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3,
respectively. Depreciation expense in Years 1, 2, and 3 is $39,765, $54,225, and
$18,075. The depreciation tax savings is calculated as the tax rate (35%) times
the depreciation expense in each year.

c. The terminal year cash flow is $50,702:

Salvage value
Tax on SV*
Return of NWC

$65,000
(19,798)
5,500
$50,702

BV in Year 4 = $120,500(0.07) = $8,435.

*Tax on SV = ($65,000 - $8,435)(0.35) = $19,798.
d. The project has an NPV of $10,841; thus, it should be accepted.
Year Net Cash Flow PV @ 12%
0
($126,000)
($126,000)
1
42,518
37,963
2
47,579
37,930
3
85,628
60,948
NPV = $ 10,841
Alternatively, place the cash flows on a time line:
0
|

12%

-126,000

42,518

47,579

34,926
50,702
85,628

With a financial calculator, input the appropriate cash flows into the cash flow
register, input I = 12, and then solve for NPV = $10,841.
11-5

a. The net cost is $89,000:

Price
Modification
Change in NWC

($70,000)
(15,000)
(4,000)
($89,000)

b. The operating cash flows follow:

Year 1 Year 2 Year 3
After-tax savings $15,000 $15,000 $15,000
Depreciation shield 11,220 15,300
5,100
Net cash flow
$26,220 $30,300 $20,100

Notes:
1. The after-tax cost savings is $25,000(1 T) = $25,000(0.6)
= $15,000.
2. The depreciation expense in each year is the depreciable basis, $85,000, times the
MACRS allowance percentage of 0.33, 0.45, and 0.15 for Years 1, 2 and 3,
respectively. Depreciation expense in Years 1, 2, and 3 is $28,050, $38,250, and
$12,750. The depreciation shield is calculated as the tax rate (40%) times the
depreciation expense in each year.
c. The additional end-of-project cash flow is $24,380:
Salvage value
Tax on SV*
Return of NWC

$30,000
(9,620)
4,000
$24,380

*Tax on SV = ($30,000 - $5,950)(0.4) = $9,620.

Note that the remaining BV in Year 4 = $85,000(0.07) = $5,950.
d. The project has an NPV of -$6,705. Thus, it should not be accepted.
Year
0
1
2
3

Net Cash Flow

PV @ 10%
($89,000)
($89,000)
26,220
23,836
30,300
25,041
44,480
33,418
NPV = ($ 6,705)

Alternatively, with a financial calculator, input the following: CF0 = -89000, CF1 =
26220, CF2 = 30300, CF3 = 44480, and I = 10 to solve for NPV = -$6,703.83.

Chapter 16
Capital Structure Decisions: The Basics
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
16-5

a. BEAs unlevered beta is bU=bL/(1+ (1-T)(D/S))=1.0/(1+(1-0.40)(20/80)) = 0.870.

b. bL = bU (1 + (1-T)(D/S)).
At 40 percent debt: bL = 0.87 (1 + 0.6(40%/60%)) = 1.218.
rS = 6 + 1.218(4) = 10.872%
c. WACC = wd rd(1-T) + wers
= (0.4)(9%)(1-0.4) + (0.6)(10.872%) = 8.683%.
V=

16-6

FCF
( EBIT)(1 T ) ($14.933)(1 0.4)
= $103.188 million.
=
=
WACC
WACC
0.08683

Tax rate = 40%

bU = 1.2

rRF = 5.0%
rM rRF = 6.0%

From data given in the problem and table we can develop the following table:

0.00
0.20
0.40
0.60
0.80

D/A

E/A

D/E

1.00
0.80
0.60
0.40
0.20

0.0000
0.2500
0.6667
1.5000
4.0000

7.00%
8.00
10.00
12.00
15.00

rd
4.20%
4.80
6.00
7.20
9.00

rd(1 T)
1.20
1.38
1.68
2.28
4.08

Leveraged
betaa
12.20%
13.28
15.08
18.68
29.48

rsb

WACCc

12.20%
11.58
11.45
11.79
13.10

Notes:
a
These beta estimates were calculated using the Hamada equation,
b = bU[1 + (1 T)(D/E)].
b
These rs estimates were calculated using the CAPM, rs = rRF + (rM rRF)b.
c
These WACC estimates were calculated with the following equation:
WACC = wd(rd)(1 T) + (wc)(rs).
The firms optimal capital structure is that capital structure which minimizes the firms
WACC. Elliotts WACC is minimized at a capital structure consisting of 40% debt and
60% equity. At that capital structure, the firms WACC is 11.45%.

Chapter 23
Derivatives and Risk Management

SOLUTIONS TO END-OF-CHAPTER PROBLEMS

23-3

If Carter issues floating rate debt and then swaps, its net cash flows will be: -(LIBOR +
2%) 7.95% + LIBOR = -9.95%. This is less than the 10% rate at which it could
directly issue fixed rate debt, so the swap is good for Carter.
If Brence issues fixed rate debt and then swaps, its net cash flows will be: -11% + 7.95%
- LIBOR = -(LIBOR + 3.05%). This is less than the rate at which it could directly issue
floating rate debt (LIBOR + 3%), so the swap is good for Brence.

Chapter 26
Multinational Financial Management
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
26-1

$1 = 9 Mexican pesos; $1 = 111.23 Japanese yen; Cross exchange rate, yen/peso = ?

Cross Rate:

Yen
Dollar
Yen
.

=
Peso
Peso Dollar

Note that an indirect quotation is given for Mexican; however, the cross rate formula
requires a direct quotation. The indirect quotation is the reciprocal of the direct
quotation. Since $1 = 9 pesos, then 1 peso = $0.1111.
Yen/Peso = 0.1111 dollars per peso 111.23 yen per dollar
= 12.358 yen per peso.
26-2

rNom, 6-month T-bills = 7%; rNom of similar default-free 6-month Japanese bonds = 5.5%;
Spot exchange rate: 1 Yen = $0.009; 6-month forward exchange rate = ft = ?
ft
(1 + rh )
=
e 0 (1 + rf )

rf = 5.5%/2 = 2.75%.
rh = 7%/2 = 3.5%.
e0 = $0.009.

ft
$0.009

1.0275 ft

= $0.00932

ft

= $0.00907.

1.035
1.0275

The 6-month forward exchange rate is 1 yen = $0.00907.

26-3

U. S. T.V. = $500; French T.V. = 550 euros; Spot rate between euro and dollar = ?
Ph = Pf(e0)
$500 = 550 euros(e0)
500/550 = e0
$0.9091 = e0.
1 euro = $0.9091 or $1 = 1 / 0.9091 = 1.1000 euros.

26-4

Dollars should sell for 1/1.50, or 0.6667 pounds per dollar.

26-8

a. The automobiles value has increased because the dollar has declined in value relative
to the yen.
b. 245/108 = 2.2685, so $8,000 2.1491 = $18,148.00.
Note that this represents a 4.9% compound annual increase over 17 years.

26-9

a. SFr. 1,000,000 (1.6590 $/SFr.) = $1,659,000, or

SFr. 1,000,000 / $0.6028 = $1,658,925.
(Difference is due to rounding.)
b. SFr. 1,000,000/SFr. 0.6075 = $1,646,091, or
FF. 1,000,000 $1.6460 = $1,646,000.
c. If the exchange rate is SFr. 0.500 to $1 when payment is due in 3 months, the SFr.
1,000,000 will cost:
SFr. 1,000,000/SFr. 0.500 = $2,000,000,
which is more than the spot price today and more than purchasing a forward contract
for 90 days.