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31 Mar 2019

You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to $450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the upgrade with cash and not to take out loans. Right now, you have $300,000 in a bank account established for Capital Investments. This account pays 6% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projected after-tax cash flows: Year Projected Cash Flow 1 $94,000 2 $114,000 3 $134,000 4 $114,000 5 $94,000 Based on this information, answer the following questions: 1) How much money will be in the bank account if you leave the $300,000 alone until you need it in five years? 2) If you undertake the investment opportunity, what is the Nominal Payback Period? 3) Using the factors for 6%, what is the Discounted Payback Period? 4) What is the Net Present Value of this investment opportunity? 5) Which option – make the investment or leave the money in a savings account – would you recommend to would you recommend to your CEO? Why? What additional factors/information might make you change your point of view? Also how would you show your work using excel

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Jarrod Robel
Jarrod RobelLv2
2 Apr 2019

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1) Analysts predict that your company's earnings will grow at 40% per year for the next five years. After that, earnings growth is expected to slow to 2% per year and continue at that level forever. Your company has announced earnings of $2 million. What is the Present Value of all future earnings if the interest rate is 10%? (Assume all cash flows occur at the end of the year.)

2) The house costs $200,000. You have $29,000 in cash that you can use as a down payment on the house, but you need to borrow the rest of the purchase price. The bank is offering a 30-year mortgage that requires annual payments and has an interest rate of 8% per year. What will your annual payment be if you sign up for this mortgage?

3) You decice you need to save $2,000,000 by the time you are 65. Today is your 30th birthday and you decide starting today, and continuing on every birthday including your 65th birthday, that you will put the same amount into a savings account. If the interest rate is 7%, the amount you deposite each year to make sure that you will have $2,000,000 in the account on your 65th birthday?

4) You have an investment opportunity that requires an initial investment of $9,500 today and will pay $9,000 in one year. What is the IRR of this opportunity?

ATC Corporation is a manufacturer of new and replacement parts for the aircraft industry. The company’s major customers are airlines, other aircraft operators (such as charter services), and contract maintenance service providers. Despite the economic slowdown, the company expects its sales to be strong for the several years, since many aircraft operators will be more interested in maintaining and repairing existing planes rather than buying new ones. At the present time, ATC is considering an upgrade to its manufacturing facility. This will involve replacing several older machines by the purchase and installation of a new, state of the art, computer-controlled metal cutting and shaping machine center made by a German supplier. Estimates of the machine center’s costs and benefits are shown in the table below, where net cash flows are after-tax. Although the machinery should last for at least ten years, the company uses a five-year planning period for equipment of this type (based on depreciation rules and company policy). Since the machine will not be sold at the end of year 5, there is no salvage value to consider. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial Costs: Purchase -3,600,000 Shipping -150,000 Installation -250,000 Cash Inflows: Sale of Old Machines 200,000 Investment Tax Credit 350,000 After-Tax Cost Savings 400,000 420,000 440,000 460,000 480,000 After-Tax New Sales 0 50,000 100,000 120,000 150,000 Depreciation Tax Savings 350,000 600,000 430,000 300,000 200,000 Increased Product Quality 10,000 20,000 25,000 30,000 35,000 Net Cash Flows: -3,450,000 760,000 1,090,000 995,000 910,000 865,000 Three important things to note are that the above cash flows have been adjusted to include an assumed inflation rate of 3% per year, the company’s average tax rate is 30%, and that the investment project is considered to be 20% riskier than the company’s average investment. Examination of ATC’s balance sheet reveals that the company uses the following types of financing (all percentages are based on market value). Financing Type Percentage of Total Financing Market Rate of Return Short-Term Debt 15% 3.5% Long-Term Debt 30% 5.25% Preferred Equity 10% 8% Common Equity 45% 12% If ATC does not make this equipment investment, it has no other real asset investment projects which it is considering. Therefore, an alternative use of the money in the capital budget would be a purely financial investment, such as stock, bonds, short-term CD’s, and so forth. 1. Based on your knowledge of current and projected economic conditions, does the company’s assumption about future sales sound reasonable to you? Why or why not? 2. What cost of capital should the company use to analyze this investment project? 3. Without considering any other alternatives, is the machine a good investment for the company? Why or why not? 4. Without doing any calculations, discuss some possible alternatives which the company might have in terms of financial investments. Give some specific examples and make sure that you include a consideration of risk as part of your discussion. 5. Which choice would you recommend for the company? Why do you consider this option the best choice? 6. Suppose you are convinced that inflation over the next several years will be higher than the 3% which is forecast in the numbers the company is using in their projections. Without doing any further calculations, explain how you could adjust your analysis to account for this.

1. A project requires an investment of $1,000,000. Although sales will begin in the first year, operations will not achieve full scale until Year 2. After that, growth is expected to be strong. The product is expected to sell for $100 per unit. Variable costs per unit are $60. Allocable fixed costs are $300,000 per year. Projected units produced and sold per year are:

Year Units

0 NA

1 5,000

2 10,000

3 12,000

4 14,000

5 16,000

At the end of Year 5, the value of the project as an ongoing concern will be 2.5x net operating profit (assume positive cash flow = net operating profit throughout the projection)

1. At what quantity is breakeven achieved?

2. During which year is that achieved?

3. Using an average of 13,000 units sold after Year 1, and incorporating the year 1 loss as an investment, how many years after year 1 will it take to achieve payback?

4. The company uses a required rate of 12%; it also assigns an ongoing value of 2.5 times year 5 net operating profit to the project. What is the NPV for the five year projection?

5. Based on your answers to 1-4, would you recommend that the company proceed with the project?

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