This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for $3.9 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $4.1 million on an aftertax basis. In five years, the aftertax value of the land will be $4.4 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $37 million to build. The following market data on DEI’s securities are current: Debt: 205,000 bonds with a coupon rate of 5.8 percent outstanding, 25 years to maturity, selling for 106 percent of par; the bonds have a $1,000 par value each and make semiannual payments. Common stock: 8,600,000 shares outstanding, selling for $67 per share; the beta is 1.15. Preferred stock: 500,000 shares of 4 percent preferred stock outstanding, selling for $83 per share, and a par value of $100. Market: 7 percent expected market risk premium; 3.1 percent risk- free rate. DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 7 percent on new common stock issues, 5 percent on new preferred stock issues, and 3 percent on new debt issues. Wharton has included all direct and indirect issuance costs (along with its profit) in setting these spreads. Wharton has recommended to DEI that it raise the funds needed to build the plant by issuing new shares of common stock. DEI’s tax rate is 25 percent. The project requires $1.5 million in initial net working capital investment to get operational. Assume DEI raises all equity for new projects externally. a. Calculate the project’s initial Time 0 cash flow, taking into account all side effects. b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI’s project. c. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation to a zero salvage value. At the end of the project (that is, the end of Year 5), the plant and equipment can be scrapped for $4.9 million. What is the aftertax salvage value of this plant and equipment? d. The company will incur $6.9 million in annual fixed costs. The plan is to manufacture 8,500 RDSs per year and sell them at $13,450 per machine; the variable production costs are $10,600 per RDS. What is the annual operating cash flow (OCF) from this project? e. DEI’s comptroller is primarily interested in the impact of DEI’s investments on the bottom line of reported accounting statements. What will you tell her is the accounting break-even quantity of RDSs sold for this project? f. Finally, DEI’s president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project’s internal rate of return and net present value are. What will you report?
> Assume that the following balance sheets are stated at book value. Suppose that Meat Co. purchases Loaf, Inc. The fair market value of Loafâ€™s fixed assets is $11,500 versus the $8,300 book value shown. Meat pays $18,400 for Loaf and
> Consider the following premerger information about Firm X and Firm Y: Assume that Firm X acquires Firm Y by issuing new long-term debt for all the shares outstanding at a merger premium of $5 per share. Assuming that neither firm has any debt before th
> Harrods PLC has a market value of £85 million and 4.5 million shares outstanding. Selfridge Department Store has a market value of £30 million and 1.8 million shares outstanding. Harrods is contemplating acquiring Selfridge. Harrods’s CFO concludes that
> Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan Delivery. Neither firm has debt. The forecasts of Fly-By-Night show that the purchase would increase its annual aftertax cash flow by $345,000 indefinitely. The current marke
> Consider the following premerger information about Firm A and Firm B: Assume that Firm A acquires Firm B via an exchange of stock at a price of $61 for each share of Bâ€™s stock. Both Firm A and Firm B have no debt outstanding. a. What
> Pearl, Inc., has offered $197 million cash for all of the common stock in Jam Corporation. Based on recent market information, Jam is worth $178 million as an independent operation. If the merger makes economic sense for Pearl, what is the minimum estima
> Dani Corp. has 5.5 million shares of common stock outstanding. The current share price is $83, and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $80 million, a coupon rate of 5.
> You own a lot in Key West, Florida, that is currently unused. Similar lots have recently sold for $1.35 million. Over the past five years, the price of land in the area has increased 7 percent per year, with an annual standard deviation of 35 percent. A
> What are the deltas of a call option and a put option with the following characteristics? What does the delta of the option tell you?
> What are the prices of a call option and a put option with the following characteristics? Stock price = $58 Exercise price = $60 Risk-free rate = 2.7% per year, compounded continuously Maturity = 4 months Standard deviation = 47% per year
> A put option and a call option with an exercise price of $65 and three months to expiration sell for $5.27 and $1.04, respectively. If the risk-free rate is 3.1 percent per year, compounded continuously, what is the current stock price?
> A put option that expires in six months with an exercise price of $45 sells for $4.84. The stock is currently priced at $43, and the risk-free rate is 3.5 percent per year, compounded continuously. What is the price of a call option with the same exercis
> A stock is currently selling for $73 per share. A call option with an exercise price of $70 sells for $5.27 and expires in three months. If the riskfree rate of interest is 2.6 percent per year, compounded continuously, what is the price of a put option
> The put-call parity condition is altered when dividends are paid. The dividend-adjusted put-call parity formula is: S × e–dt + P = E × e–Rt + C where d is again the continuously compounded dividend yield. a. What effect do you think the dividend yield wi
> In addition to the five factors discussed in the chapter, dividends also affect the price of an option. The Black-Scholes option pricing model with dividends is: All of the variables are the same as the Black-Scholes model without dividends except for
> Marshall Corp. has a zero coupon bond that matures in five years with a face value of $75,000. The current value of the company’s assets is $71,000, and the standard deviation of its return on assets is 34 percent per year. The risk-free rate is 7 percen
> Zoso Industries has a zero coupon bond issue that matures in two years with a face value of $50,000. The current value of the company’s assets is $34,600, and the standard deviation of the return on assets is 60 percent per year. a. Assume the risk-free
> Fama’s Llamas has a weighted average cost of capital of 8.4 percent. The company’s cost of equity is 11 percent, and its pretax cost of debt is 5.8 percent. The tax rate is 25 percent. What is the company’s target debt-equity ratio?
> A company has a single zero coupon bond outstanding that matures in five years with a face value of $16.5 million. The current value of the company’s assets is $15.1 million, and the standard deviation of the return on the firm’s assets is 41 percent per
> If you need $25,000 in 12 years, how much will you need to deposit today if you can earn 7 percent per year compounded continuously?
> Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $20,000 that matures in one year. The current market value of the firm’s assets is $23,100. The standard deviation of the return on the firm’s assets is 38 percent per ye
> Suppose the firm in Problem 16 is considering two mutually exclusive investments. Project A has an NPV of $2,400, and Project B has an NPV of $2,800. As the result of taking Project A, the standard deviation of the return on the firm’s assets will increa
> Sunburn Sunscreen has a zero coupon bond issue outstanding with a $10,000 face value that matures in one year. The current market value of the firm’s assets is $10,900. The standard deviation of the return on the firm’s assets is 31 percent per year, and
> A call option has an exercise price of $70 and matures in six months. The current stock price is $73, and the risk-free rate is 5 percent per year, compounded continuously. What is the price of the call if the standard deviation of the stock is 0 percent
> A call option with an exercise price of $25 and four months to expiration has a price of $3.10. The stock is currently priced at $25.19, and the risk-free rate is 2.5 percent per year, compounded continuously. What is the price of a put option with the s
> You are given the following information concerning options on a particular stock: Stock price = $64 Exercise price = $60 Risk-free rate = 2% per year, compounded continuously Maturity = 6 months Standard deviation = 57% per year a. What is the intrinsic
> In Problem 9, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today? Problem 9: You own a lot in Key West
> If you have $1,490 today, how much will it be worth in six years at 9 percent per year compounded continuously?
> Brannan Manufacturing has a target debt-equity ratio of .35. Its cost of equity is 11 percent, and its pretax cost of debt is 6 percent. If the tax rate is 21 percent, what is the company’s WACC?
> A $1,000 par convertible debenture has a conversion price for common stock of $18 per share. With the common stock selling at $25, what is the conversion value of the bond?
> Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of the company’s assets is currently $1,060. The CEO believes that the assets in the company will be worth either $940 or $1,250 in a year. The goin
> Rackin Pinion Corporation’s assets are currently worth $1,030. In one year, they will be worth either $1,000 or $1,270. The risk-free interest rate is 3.7 percent. Suppose the company has an outstanding debt issue with a face value of $1,000. a. What is
> A one-year call option contract on Cheesy Poofs Co. stock sells for $725. In one year, the stock will be worth $64 or $81 per share. The exercise price on the call option is $70. What is the current value of the stock if the risk-free rate is 3 percent?
> The price of Cilantro, Inc., stock will be either $60 or $80 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 6 percent. a. Suppose the current price of the company’s stock is $70. What is the value
> The price of Chive Corp. stock will be either $57 or $84 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 4 percent. a. Suppose the current price of the company’s stock is $65. What is the value of t
> Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $40. a. Suppose you buy 10 contracts of the February 38 call option. How much will you pay, ignoring commissions? b. In part (a), suppos
> Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $12 million that will be depreciated straight-line to zero
> You have been hired to value a new 25-year callable, convertible bond. The bond has a coupon rate of 2.1 percent, payable annually. The conversion price is $54, and the stock currently sells for $26.45. The stock price is expected to grow at 11 percent p
> Liberty Products, Inc., is considering a new product launch. The firm expects to have annual operating cash flow of $4.9 million for the next eight years. The company uses a discount rate of 11 percent for new product launches. The initial investment is
> The Tribiani Co. just issued a dividend of $2.90 per share on its common stock. The company is expected to maintain a constant 4.5 percent growth rate in its dividends indefinitely. If the stock sells for $56 a share, what is the company’s cost of equity
> Campbell, Inc., has a $1,000 face value convertible bond issue that is currently selling in the market for $960. Each bond is exchangeable at any time for 17 shares of the company’s stock. The convertible bond has a 4.6 percent coupon, payable semiannual
> Which of the following two sets of relationships, at time of issuance for convertible bonds, is more typical? Why?
> Suppose a share of stock sells for $54. The risk-free rate is 5 percent, and the stock price in one year will be either $60 or $70. a. What is the value of a call option with an exercise price of $60? b. What’s wrong here? What would you do?
> In Problem 15, suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold. Naturally, expansion would be desirable only if the project is a success. This implies that if the project is a suc
> In Problem 14, suppose you think it is likely that expected sales will be revised upward to 11,400 units if the first year is a success and revised downward to 3,500 units if the first year is not a success. a. If success and failure are equally likely,
> We are examining a new project. We expect to sell 7,400 units per year at $59 net cash flow apiece for the next 10 years. In other words, the annual cash flow is projected to be $59 × 7,400 = $436,600. The relevant discount rate is 14 percent, and the in
> A bond with 20 detachable warrants has just been offered for sale at $1,000. The bond matures in 20 years and has an annual coupon of $18. Each warrant gives the owner the right to purchase two shares of stock in the company at $45 per share. Ordinary bo
> You have been hired to value a new 30-year callable, convertible bond. The bond has a coupon rate of 2.3 percent, payable semiannually, and its face value is $1,000. The conversion price is $49, and the stock currently sells for $38. a. What is the minim
> T-bills currently yield 3.4 percent. Stock in Deadwood Manufacturing is currently selling for $67 per share. There is no possibility that the stock will be worth less than $60 per share in one year. a. What is the value of a call option with a $55 exerci
> Refer to Table 23.1 in the text to answer this question. Suppose your firm produces breakfast cereal and needs 165,000 bushels of corn in December 2020 for an upcoming promotion. You would like to lock in your costs today because you are concerned that c
> Suppose your company has a building worth $125 million. Because it is located in a high-risk area for natural disasters, the probability of a total loss in any particular year is 1.05 percent. What is your company’s expected loss per year on this buildin
> Refer to Table 23.2 in the text to answer this question. Suppose you purchase the July 2020 put option on corn futures with a strike price of $3.25. Assume your purchase was at the last price. What is the total cost? Suppose the price of corn futures is
> Refer to Table 23.2 in the text to answer this question. Suppose you purchase the July 2020 call option on corn futures with a strike price of $3.25. Assume you purchased the option at the last price. How much does your option cost per bushel of corn? Wh
> Refer to Table 23.1 in the text to answer this question. Suppose you sell five July 2020 silver futures contracts this day at the last price of the day. What will your profit or loss be if silver prices turn out to be $17.68 per ounce at expiration? What
> Refer to Table 23.1 in the text to answer this question. Suppose you purchase a September 2020 cocoa futures contract this day at the last price of the day. What will your profit or loss be if cocoa prices turn out to be $2,308 per metric ton at expirati
> Suppose your company imports computer motherboards from Singapore. The exchange rate is given in Figure 21.1. You have just placed an order for 30,000 motherboards at a cost to you of 218.50 Singapore dollars each. You will pay for the shipment when it a
> Suppose the current exchange rate for the Polish zloty is Z 3.91. The expected exchange rate in three years is Z 3.98. What is the difference in the annual inflation rates for the United States and Poland over this period? Assume that the anticipated rat
> The treasurer of a major U.S. firm has $30 million to invest for three months. The interest rate in the United States is .15 percent per month. The interest rate in Great Britain is .26 percent per month. The spot exchange rate is £.813, and the three-mo
> Suppose the Japanese yen exchange rate is ¥116 = $1, and the British pound exchange rate is £1 = $1.27. a. What is the cross-rate in terms of yen per pound? b. Suppose the cross-rate is ¥156 = £1. Is there an arbitrage opportunity here? If there is, expl
> Chauhan Corp. has a debt-equity ratio of .65. The company is considering a new plant that will cost $55 million to build. When the company issues new equity, it incurs a flotation cost of 6 percent. The flotation cost on new debt is 2.4 percent. What is
> Suppose the spot exchange rate for the Canadian dollar is Can$1.34 and the six-month forward rate is Can$1.41. a. Which is worth more, a U.S. dollar or a Canadian dollar? b. Assuming absolute PPP holds, what is the cost in the United States of an Elkhead
> In Problem 16, assume the equity increases by 1,250 solaris due to retained earnings. If the exchange rate at the end of the year is 1.54 solaris per dollar, what does the balance sheet look like? Problem 16: Atreides International has operations in Arr
> Atreides International has operations in Arrakis. The balance sheet for this division in Arrakeen solaris shows assets of 39,000 solaris, debt in the amount of 11,000 solaris, and equity of 28,000 solaris. a. If the current exchange ratio is 1.50 solaris
> You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 13.8 million. The cash flows from the project would be SF 4.1 million per year for the next five years. The dollar required re
> Lakonishok Equipment has an investment opportunity in Europe. The project costs €9.5 million and is expected to produce cash flows of €1.6 million in Year 1, €2.1 million in Year 2, and €3.2 million in Year 3. The current spot exchange rate is €.94/$ and
> Suppose the spot exchange rate for the Hungarian forint is HUF 308.27. The inflation rate in the United States will be 2.6 percent per year. It will be 4.5 percent in Hungary. What do you predict the exchange rate will be in one year? In two years? In fi
> Suppose the spot and three-month forward rates for the yen are ¥114.37 and ¥113.89, respectively. a. Is the yen expected to get stronger or weaker? b. What would you estimate is the difference between the annual inflation rates of the United States and J
> You observe that the inflation rate in the United States is 2.6 percent per year and that T-bills currently yield 3.2 percent annually. Using the approximate international Fisher effect, what do you estimate the inflation rate to be in: a. Australia, if
> Suppose the spot and six-month forward rates on the Norwegian krone are Kr 9.14 and Kr 9.27, respectively. The annual riskfree rate in the United States is 3.8 percent, and the annual risk-free rate in Norway is 5.7 percent. a. Is there an arbitrage oppo
> Air Spares is a wholesaler that stocks engine components and test equipment for the commercial aircraft industry. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $1.325 million p
> Suppose you observe the following situation: a. Calculate the expected return on each stock. b. Assuming the capital asset pricing model holds and Stock Aâ€™s beta is greater than Stock Bâ€™s beta by .35, what is the exp
> The Paa Ko Corporation sells on credit terms of net 30. Its accounts are, on average, four days past due. If annual credit sales are $7.2 million, what is the company’s balance sheet amount in accounts receivable?
> Essence of Skunk Fragrances, Ltd., sells 9,300 units of its perfume collection each year at a price per unit of $415. All sales are on credit with terms of 1/10, net 40. The discount is taken by 45 percent of the customers. What is the amount of the comp
> Benton, Inc., has an average collection period of 24 days. Its average daily investment in receivables is $49,300. What are annual credit sales? What is the receivables turnover? Assume 365 days per year.
> Sweetens Cove, Inc., has weekly credit sales of $23,400, and the average collection period is 31 days. What is the average accounts receivable figure?
> Kyoto Joe, Inc., sells earnings forecasts for Japanese securities. Its credit terms are 2/10, net 30. Based on experience, 65 percent of all customers will take the discount. a. What is the average collection period for the company? b. If the company s
> In Problem 21, assume that the probability of default is 15 percent. Should the orders be filled now? Assume the number of repeat customers is affected by the defaults. In other words, 30 percent of the customers who do not default are expected to be rep
> Solar Engines manufactures solar engines for tractor-trailers. Given the fuel savings available, new orders for 125 units have been made by customers requesting credit. The variable cost is $14,800 per unit, and the credit price is $16,100 each. Credit i
> The Caccamisse Corporation has annual sales of $29 million. The average collection period is 34 days. What is the average investment in accounts receivable as shown on the balance sheet? Assume 365 days per year.
> In Problem 15, what is the break-even price per unit under the new credit policy? Assume all other values remain the same. Problem 15: Fitzgerald, Inc., currently has an all-cash credit policy. It is considering making a change in the credit policy by g
> In Problem 14, what is the break-even quantity for the new credit policy? Problem 14: The Branson Corporation is considering a change in its cash-only policy. The new terms would be net one period. Based on the following information, determine if the co
> Suppose you observe the following situation: Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate?
> Fitzgerald, Inc., currently has an all-cash credit policy. It is considering making a change in the credit policy by going to terms of net 30 days. Based on the following information, what do you recommend? The required return is .85 percent per month.
> The Branson Corporation is considering a change in its cash-only policy. The new terms would be net one period. Based on the following information, determine if the company should proceed or not. The required return is 2.3 percent per period.
> The Trektronics store begins each week with 380 phasers in stock. This stock is depleted each week and reordered. If the carrying cost per phaser is $31 per year and the fixed order cost is $325, what is the total carrying cost? What is the restocking co
> Queen Manufacturing uses 3,900 switch assemblies per week and then reorders another 3,900. If the relevant carrying cost per switch assembly is $6.25, and the fixed order cost is $1,400, is the company’s inventory policy optimal? Why or why not?
> Red Hawk, Inc., is considering a change in its cash-only sales policy. The new terms of sale would be net one month. Based on the following information, determine if the company should proceed or not. Describe the buildup of receivables in this case. The
> You place an order for 250 units of inventory at a unit price of $190. The supplier offers terms of 1/10, net 30. a. How long do you have to pay before the account is overdue? If you take the full period, how much should you remit? b. What is the disco
> Every two weeks, No More Pencils, Inc., disburses checks that average $124,000 and take seven days to clear. How much interest can the company earn annually if it delays transfer of funds from an interest-bearing account that pays .009 percent per day fo
> It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. The company’s management is considering a lockbox system to reduce the firm’s collection times. It is expected that the lockbox system will reduce re
> Paper Submarine Manufacturing is investigating a lockbox system to reduce its collection time. It has determined the following: Average number of payments per day …………………………………………. 435 Average value of payment ………………………………………………………… $845 Variable lockb
> A mail-order firm processes 5,800 checks per month. Of these, 60 percent are for $49 and 40 percent are for $84. The $49 checks are delayed two days on average; the $84 checks are delayed three days on average. Assume 30 days in a month. a. What is the a
> Consider the following information about Stocks I and II: The market risk premium is 7 percent, and the risk-free rate is 3.5 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is â€œ
> Your firm has an average receipt size of $135. A bank has approached you concerning a lockbox service that will decrease your total collection time by two days. You typically receive 4,900 checks per day. The daily interest rate is .016 percent. If the b
> Your neighbor goes to the post office once a month and picks up two checks, one for $8,450 and one for $4,200. The larger check takes four days to clear after it is deposited; the smaller one takes three days. Assume 30 days in a month. a. What is the to
> Purple Feet Wine, Inc., receives an average of $18,600 in checks per day. The delay in clearing is typically three days. The current interest rate is .017 percent per day. a. What is the company’s float? b. What is the most the company should be willing
> Each business day, on average, a company writes checks totaling $19,500 to pay its suppliers. The usual clearing time for the checks is four days. Meanwhile, the company is receiving payments from its customers each day in the form of checks totaling $24
> Bird’s Eye Treehouses, Inc., a Kentucky company, has determined that a majority of its customers are located in the Pennsylvania area. It therefore is considering using a lockbox system offered by a bank located in Pittsburgh. The bank has estimated that
> No More Books Corporation has an agreement with Floyd Bank whereby the bank handles $3.4 million in collections per day and requires a $320,000 compensating balance. No More Books is contemplating canceling the agreement and dividing its eastern region s
> In a typical month, the Montrose Corporation receives 90 checks totaling $85,000. These are delayed four days on average. What is the average daily float? Assume 30 days in a month.