Documente Academic
Documente Profesional
Documente Cultură
= =
(
(
(
[2 points]
ProModel:
( ) ( )
( )
5
$5,000 1 1.10
$10,000 28,954
0.10
NPV
= + = [2 points]
( )
5
$28,954
$7,638
1 1.10
0.10
EANPV
= =
(
(
(
[2 points]
The equivalent cost per year is $7,108 for ExcelModel and $7,638 for the ProModel. To
lower costs, choose ExcelModel. [1 point]
8
22. (11 points) Great Falls Refining Inc. bought Equipment M1 for $150,000 and Equipment S2
for $250,000 exactly twenty-five years ago (today is the first day of the 26th year from the
point of initial purchase). Both equipments belong to the Class 8 assets with CCA rate of
20%. There was no other asset in Class 8 when these two equipments were purchased. After
(exactly) 11 years of initial purchase, Equipment S2 was sold for $10,000, and Equipment
M1 became the only Class 8 asset. Yesterday (at the end of 25th year), Equipment M1 was
sold for $175,000. What is the current (post-sale) total tax liability of Great Falls Inc. if it has
a tax rate of 32%?
Equipments M1 and S2 were purchased at the beginning of year 25 (twenty-five years ago);
S2 was sold at the end of year 15 (eleven years after initial purchase); M1 was sold just
now.
When both M1 and S2 were purchased twenty-five years ago:
25_
$150,000 $250,000 $400,000
beg
UCCP
= + = [1 point]
J ust prior to the sale of S2 at the end of 11
th
year:
( ) ( )
12 2
15_
$400,000* 1 0.1 * 1 0.2 $38,655
end
UCCP
= = [2 points]
There is no tax implication arising from the sale of S2.
Revised UCCP following the sale of S2:
| |
14_
$38,655 min $250,000; $10,000 $28,655
beg
UCCP
= = [2 points]
J ust prior to the sale of M1 yesterday after 14 years of being the sole asset in Class 8:
( )
14
0 1_
$28,655 1 0.2 $1,260
end
UCCP UCCP
= = = [2 points]
Since, for M1, SV > C > UCCP, there is capital gains as well as CCA Recapture.
Capital gains tax =0.5 * ($175,000 $150,000) * 0.32 =$4,000 [2 points]
CCA recapture tax =($150,000 $1,260) * 0.32 = $47,597 [1 point]
Total tax liability =$51,597 [1 point]
9
23. (16 points) Abbott Industries currently has 5 million common shares trading at $25 each, 0.5
million preferred shares trading at $50 each, and 100,000 bonds trading at 90% of par.
The bonds have a maturity of 20 years and pay semiannual coupons at 5.5%. The preferred
shares pay annual dividends of $3.50 per share. The stock pays annual dividends; the recently
paid dividend was $1.96 and dividends grow at a constant rate of 2%. In addition, the stock
beta is 1.57, average risk free rate is 1%, and average return on market index is 7%.
Abbott is considering undertaking a new project whose risk matches the risk of the firm.
Retained earnings are insufficient to finance the new project. Abbott decides to issue new
bonds, common stock and preferred shares with the same terms and features as the existing
securities (that is, same bond maturity and coupon rate, and same dividend amounts and
growth rate). The plan involves issuing 3,000 new bonds, 6,000 new preferred shares, and
280,000 new common shares.
In response to the announcement that Abbott is planning to issue new securities, the prices of
common shares and preferred shares drop by $1 and $2 respectively, and the prices of bonds
drop by 1% of par. All new securities are issued at the lower market prices.
In addition, the intermediary investment bank charges underwriting fees for issuing equity;
these fees translate to $0.25 per share when all existing and new common shares are taken
into account.
What is the value of weighted average cost of capital (WACC) that Abbott needs to apply to
evaluate the new project? Abbotts tax rate is 28%.
Capital structure of the firm (that is, relative market value proportions of the securities) and
the component costs of capital need to be computed after taking into consideration the
issuance of new securities.
After the issuance of new securities,
market value of equity =(5,000,000 +280,000) * ($25 $1) =$126.720M [2 points]
market value of preferred stock =(500,000 +6,000) * ($50 $2) =$24.288M [2 points]
market value of debt =(100,000 +3,000) * (90% 1%) * $1,000 =$91.670M [2 points]
total market value of firm =$242.678M
10
(PLEASE USE THI S PAGE TO CONTI NUE PROBLEM 23)
Post-issuance costs of capital:
cost of preferred shares
( )
$3.50
7.29%
$50 $2
= =
[2 points]
cost of debt (approx.)
( )
( )
$1,000 $890
$27.50
40
$1,000 $890
2
+
=
+
=3.20% for year; 6.40% per year
alternatively, cost of debt (approx.)
( )
( )
$1,000 $890
$55
20
$1,000 $890
2
+
=
+
=6.40%
after-tax cost of debt =(1 0.28) * 6.40% =4.61%
cost of equity (dividend discount method)
( )
( )
$1.96* 1.02
2% 10.42%
$25 $1 $0.25
= + =
cost of equity (CAPM method) =1% +1.57 * (7% 1%) =10.42%
Weighted-average cost of capital, WACC
$91.670 $24.288 $126.720
*4.61% *7.29% *10.42% 7.91%
$242.678 $242.678 $242.678
| | | | | |
= + + =
| | |
\ . \ . \ .
[3 points]
Either approach is acceptable
[2 points]
Either approach is acceptable
[3 points]
11
24. (24 points) PixTel Inc. is considering replacing an old machine by a new one. The current
market value for the existing machine is $30,000, it was purchased six years ago for
$105,000. The new machine costs $90,000.
If the new machine is adopted, it will reduce before-tax maintenance cost by $20,000 per
year and save before-tax labor costs by $15,000 per year for ten years. These savings in costs
would occur at year-end. The new machine will be housed in space that would have
otherwise been rented out for $4,000 per year. Rental payments occur at the end of each year.
At the end of the tenth year, the old machine is expected to have a resale value of $4,000.
PixTel expects to sell the new machine for $10,000 after 10 years. There will be other assets
in the asset pool after ten years.
Replacement of the old machine will require that the firm set aside $30,000 towards initial
working capital. At the end of the new machines life, 50% of this working capital will be
recovered.
The new as well as the old machines qualify for a CCA rate of 20 percent. The tax rate for
PixTel is 35 percent and the appropriate discount rate is 10 percent.
Should PixTel replace its old machine?
Assuming that the old machine is the only one in its asset class, UCCP at the point of
replacement (today) ( ) ( )
5
$105,000* 1 0.1 * 1 0.2 $30,966 = = . If there are other assets in
the asset pool, UCCP today will be even higher. So there is no tax outcome if the old asset is
sold today.
Incremental initial outlay, I =$90,000 +$30,000 =$60,000 [2 points]
Total cost savings (maintenance and labor costs) per year =$20,000 +$15,000 =$35,000
Present value of incremental post-tax operating cash flows, PVATOCF
( ) ( ) ( )
( )
10
1 0.35 * $35,000 * 1 1.10
$139,789
0.10
= = [5 points]
Opportunity costs (lost rental proceeds) per year =$4,000
Present value of post-tax lost opportunity costs, PVATLOC
( ) ( ) ( )
( )
10
1 0.35 * $4,000 * 1 1.10
$15,976
0.10
= = [4 points]
Present value of incremental working capital changes, PVNWC
( )
10
$15,000
$30,000 $24,217
1 0.10
= + =
+
[3 points]
12
(PLEASE USE THI S PAGE TO CONTI NUE PROBLEM 24)
Present value of incremental CCA tax shield benefits, PVCCATS
( )
10
$60,000*0.20*0.35 1.05 1 $6,000*0.20*0.35
$12,824
0.10 0.20 1.10 0.10 0.20
1.10
| || | | |
= =
| | |
+ +
\ .\ . \ .
[5 points]
Present value of incremental salvage value, PVSV
( )
( )
10
$10,000 $4,000
$2,313
1 0.10
= =
+
[3 points]
There are no pool termination effects since there are other assets in the asset pool.
Summing up all components, NPV
=I +PVATOCF +PVATLOC +PVCCATS +PVSV +PVNWC
=$60,000 +$139,789 $15,976 +$12,824 +$2,313 $24,217
=$54,733
Since NPV >0, PixTel should replace its old machine. [2 points]