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    The Basics of Capital Budgeting: Solutions To End-Of-Chapter Problems

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    Tayeba Anwar
    This document provides solutions to problems from chapters 10, 11, 16, 23, and 26 of an investments textbook. The chapter 10 problem solutions involve calculations for capital budgeting techniques like payback period, NPV, IRR, and MIRR. The chapter 11 solutions apply cash flow estimation and risk analysis to capital budgeting problems. Chapter 16 covers capital structure decisions and the weighted average cost of capital. Derivatives and risk management are addressed in chapter 23 solutions. Finally, chapter 26 solutions involve calculations related to multinational financial management and exchange rates.

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    The Basics of Capital Budgeting: Solutions To End-Of-Chapter Problems

    Uploaded by

    Tayeba Anwar
    82 views9 pages
    This document provides solutions to problems from chapters 10, 11, 16, 23, and 26 of an investments textbook. The chapter 10 problem solutions involve calculations for capital budgeting techniques like payback period, NPV, IRR, and MIRR. The chapter 11 solutions apply cash flow estimation and risk analysis to capital budgeting problems. Chapter 16 covers capital structure decisions and the weighted average cost of capital. Derivatives and risk management are addressed in chapter 23 solutions. Finally, chapter 26 solutions involve calculations related to multinational financial management and exchange rates.

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    10.3-7 and 16

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    This document provides solutions to problems from chapters 10, 11, 16, 23, and 26 of an investments textbook. The chapter 10 problem solutions involve calculations for capital budgeting techniques like payback period, NPV, IRR, and MIRR. The chapter 11 solutions apply cash flow estimation and risk analysis to capital budgeting problems. Chapter 16 covers capital structure decisions and the weighted average cost of capital. Derivatives and risk management are addressed in chapter 23 solutions. Finally, chapter 26 solutions involve calculations related to multinational financial management and exchange rates.

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    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    82 views9 pages

    The Basics of Capital Budgeting: Solutions To End-Of-Chapter Problems

    Uploaded by

    Tayeba Anwar
    This document provides solutions to problems from chapters 10, 11, 16, 23, and 26 of an investments textbook. The chapter 10 problem solutions involve calculations for capital budgeting techniques like payback period, NPV, IRR, and MIRR. The chapter 11 solutions apply cash flow estimation and risk analysis to capital budgeting problems. Chapter 16 covers capital structure decisions and the weighted average cost of capital. Derivatives and risk management are addressed in chapter 23 solutions. Finally, chapter 26 solutions involve calculations related to multinational financial management and exchange rates.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 9

    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.

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