You have a choice between two mutually exclusive investments

1. You have a choice between two mutually exclusive investments. Project A requires initial cash outlay of $150,000 and has projected cash flows of $100,000 for year one, $55,000 for year two, and $30,000 for year three. Meanwhile, Project B requires initial cash outlay of $100,000 and has projected cash flows of $40,000 per year for the next three years. The required rate of return is 10%.

(a) Calculate the ordinary payback period for both projects and determine which should be accepted. Assume the target payback period is 2 years. Explain why.

(b) Calculate the discounted payback period for both projects and determine which should be accepted. Assume the target payback period is 2 years Explain why.

(c) Calculate the profitability index (PI) for both projects and determine which should be accepted. Explain why.

(d) Assuming the projected cash flow is a future net income, calculate the average accounting return (AAR) for both projects and determine which should be accepted if the target average accounting return is 30%. Explain why.

2. ABC Company is considering a new assembly line to replace the existing assembly line. The assembly line would require to use a parcel of land that cost $800,000 three years ago. But the land can be sold for $1,000,000 today and is expected to be sold for $1,200,000 five years from now. The company conducted a marketing survey for the feasible impact of the new assembly line, if replaced, on the company’s cash flow six months ago, costing $25,000.

The existing assembly line was installed 3 years ago at a cost of $80,000; it was being depreciated under the straight-line method. The existing assembly line is expected to have a usable life of 5 more years. The new assembly line costs $120,000; requires $5,000 in installation costs and $3,000 in training fees; it has a 5-year usable life and would be depreciated under the straight-line method.

The new assembly line will increase output and thereby raises sales by $15,000 per year and will reduce production expenses by $5,000 per year. The existing assembly line can currently be sold for $10,000. To support the increased business resulting from installation of the new assembly line, the firm will also need to increase account payables by $2,500 and decrease inventory by $1,500 for the project.

At the end of 5 years, the existing assembly line is expected to have a market value of $1,000; the new assembly line would be sold to net $20,000 before taxes. Finally, to install the new assembly line, the firm would have to borrow $80,000 at 10% interest from its local bank, resulting in additional interest payments of $8,000 per year. The firm pays 34% taxes and its shareholders require 10% return.

(a) What is the initial outlay associated with this project?
(b) What is the operating cash flow per year?
(c) What is the terminal cash flow?
(d) Find NPV for this project. Should this machine be replaced? Explain why.

3. You have a choice between two mutually exclusive investments.

(a) Find the internal rate of return (IRR) for both projects and determine which should be accepted if the required rate of return is 25%. Explain why. You need to provide equations.

(b) Find the crossover rate. You need to provide necessary steps.
4. You are comparing stock A to stock B. Consider the following table:

(a) What is the expected return of a portfolio which is comprised of $8,400 invested in stock A and $3,600 in stock B?

(b) What is the standard deviation of a portfolio which is comprised of $8,400 invested in stock A and $3,600 in stock B?

(c) Which one of these two stocks should you prefer to buy and why?

5. ABC Enterprise is considering the purchase of a new assembly line, costing $300,000. The new assembly line has a 5-year tax life and will be depreciated under straight-line. The firm estimates that in 4 years the assembly line can be salvaged for $40,000. For the next 4 years the new assembly line will increase output and thereby raises sales by $15,000 per year and will reduce production expenses by $5,000 per year. The firm also needs an initial decrease in net working capital of $20,000. Assume that

ABC’s tax rate is 34% and ABC Enterprise has the following information on its equity and bonds:
Common stock: 2 million shares outstanding, currently selling for $30 per share. ABC Enterprise expects to pay dividend of $3.00 next year and the dividend growth rate is expected to be 5%.

Bonds: 80,000 bonds outstanding, $1,000 face value for each bond, 7% coupon with 10 years to maturity, and selling for $1,150.00. The bonds pay coupons semi- annually.

ABC Enterprise plans to raise the funds needed to purchase the assembly line by issuing new common stocks and bonds.

The flotation costs of the new common stock would be 8% of the amount raised. The flotation costs of the new bonds would be 4% of the proceeds.

(a) What is the WACC of ABC Enterprise?

(b) What is the NPV of the project?