Finance Assignment Answer

(Question number 1-9)

Ans: 1 Yield to Maturity on the Mortgage Bond.
Face Value = $1000
Coupon Rate = 8%
Therefore, semi-annual rate = 4%
Coupon payment = 0.04 * 1000 = $ 40
Let half a year be1 time period.

End of Period	Cash Flow ($)
1	40
2	40
3	40
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19	40
20	1000 + 40 = 1040

Let the annual Yield to Maturity be R. => Semi-annual yield = R/2 = r
Present Value of Bond = CF1/(1+r) + CF2/(1+r)^2 + …… CF20/(1+r)^20
875 = 40/(1+r) + 40/(1+r)^2 + ….. 40/(1+r)^19 + 1040/(1+r)^20
Solve this equation for r using a financial calculator or Microsoft Excel.
r = 5%
R = 2r = 10%

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Ans 2: Let k be the cost of equity.

Using the dividend discount model.
P = D1/(k-g)
=> 27 = D0 * (1+g) / (k-g)
=> 27 = 1.215*1.08/(k- 0.08)
=> k = 0.1286 = 12.86%
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Ans 3: Total Debt (long-term) = 5,143,000
Total Equity = 500,000 + 2,000,000 + 8,640,210 = 11,140,210
D/(D+E) = 0.3158
E/(D+E) = 0.6842
Overall cost of capital = D/(D+E) * YTM + E/(D+E) * k
0.3158 * 0.1 + 0.6842* 0.1286
=0.03158 + 0.08799
= 0.1196 = 11.96%

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Ans 4: Cash Flows for automated mixer

Cost of Mixer = $240,000
MACRS Depreciation schedule:

The Revenues and Expenses both increase by 5%.We assume that the Marginal Revenues brought in by the mixer and the savings in expenses obtained also increase at 5% per annum..
The change in Working Capital is assumed to increase by 20% of the given estimates due to the mixer. Only changes due to the mixer i.e. 20% of the given estimates have been used for calculating the mixer's cash flows.
The Cash flow calculations have been shown below.

Ans 5: NPV = -240,000 + 80447/1.1196 + 92551/(1.1196^2) + 114116/(1.1196^3) +

79824/(1.1196^4) + 64357/(1.1196^5)

= $66438.97

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Ans 6: IRR is the rate used for discounting such that the NPV becomes 0.
Let the IRR be r.
-240,000 + 80447/(1+r) + 92551/(1+r)^2 + 114116/(1+r)^3 +

79824/(1+r)^4 + 64357/(1+r)^5 = 0
IRR = 24.13%

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Ans 7: The depreciation schedule for the continuous oven is as follows.

The Oven does not bring in Marginal Revenues but saves operating costs. These Savings have been assumed to grow to 5% more than today over the next 10 years. Assuming a constant increase at 1.1746%.
The estimated change in working capital is $14000 per annum. We assume 5% of this (=$700) to be because of the oven.
The Cash flow calculations are shown below.

NPV = -685000 + CF1/(1.1196) + CF2/(1.1196^2) +…… CF10/(1.1196^10)
= - $93,193.24
Even without the Working Capital assumption the NPV = -$89,655.02

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Ans 8: The depreciation schedule for the semi-automated packer is as follows.

The Oven does not bring in Marginal Revenues but saves operating costs. These Savings have been assumed to grow to 5% more than today over the next 10 years. Assuming a constant increase at 1.1746%.
The estimated change in working capital is $14000 per annum. We assume 5% of this (=$700) to be because of the oven.
The Cash flow calculations are shown below.
We assume that the previous packer was sold at its market value when the semi-automated packer was installed.

NPV = -390000 + CF1/1.1196 + CF2/(1.1196^2) + …. CF10/ (1.1196^10)
= -$29367.55

However, without the Working Capital assumption the Cash flows are

And the NPV = $128624.53

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Ans 9: Mike should undertake the automated mixer as it has a NPV = $66438.97 and an IRR of 24% i.e. greater than the overall cost of capital. Therefore, Mike should invest the $240,000 in the automated mixer.

The Continuous Oven has a negative NPV ( = -$93,193) and therefore should not be undertaken.

The Semi-automated packer has an NPV of $128,624.53. (However, the effects on Working Capital should be studied carefully as they turn the NPV negative) . The investment worth $ 390,000 should be made.
Therefore, Total Capital Expenditure for Mike = $240,000 + $390,000 = $630,000 which is less than his budget of $1,000,000.