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Financial Management Assignment




Question;INSTRUCTION;There are two parts;to this exam. The first part is problem;solving and the second part is a capital-budgeting analysis. You must show all work to receive full;credit. On the problem solving section;make sure to clearly identify your final answer. Make sure to format your work as necessary so;that it is ready for immediate printing when downloaded from the drop box for;grading purposes. For the capital;budgeting analysis, make sure to clearly identify all cash flows and compute;the NPV, IRR, and clearly state your recommendation.;Q 1.;You have finally;saved up $5,000 for a down payment for a new jet ski. After weeks of intensive research, you decide;to purchase a 2014 Kawasaki Ultra 310LX.;You will have the ultimate combination of class-leading horsepower;(310), precise handling, and superior luxury.;Sea Doo riders won?t dare mess with you.;You believe you have cut a sweet deal, negotiating the purchase price;down to $14,999 plus 7% taxes. After;making your $5,000 down payment, you will be financing the remainder. The salesperson mentions to you that you;qualify for a great interest rate and informs you that your monthly payment on;your 48 month loan will be based on an APR of 6%. He also tells you that the jet ski comes with;a 4 year warranty, so any problems that may arise will be completely covered;until you get it paid off. What is the;monthly payment on this loan? (10;points);Q 2.;Alex has not budgeted wisely. As a result, he needs a quick loan from;Maddie. Alex needs $6,000 and Maddie has;agreed to lend him the $6,000 if he makes 15 monthly payments to Maddie in the;amount of $480, to be paid at the end of each month. Because the total amount to be repaid is;$7,200, Maddie points out that she believes the interest rate is 20% ($1,200 in;interest on a $6,000 principal loan).;When pressed, Maddie acknowledges that the effective annual rate is the;true measure of the annualized interest and that it will probably be higher;because of compounding. However, neither;Maddie nor Alex knows how to calculate the effective annual rate for this loan;so they have turned to you for help.;What is the effective annual rate (E.A.R.) on this loan? (10 points);Q 3.;Microsoft?s most recent yearly dividend was $1.12. Over the past five years, Microsoft?s;dividends have experienced an average rate of growth of 15%. Use the following information to value;Microsoft?s stock using the dividend growth model. Dividends are expected to grow at a rate of;15% per year for the next 3 years. For;the following three years (i.e., years 4 ? 6), dividends will grow by 10% per;year. After that, the dividends are;projected to grow at a constant rate of 4%, forever. The firm has a debt-to-equity ratio (in;market value terms) of 0.2. The YTM on;the company?s bonds averages 4% and the company?s tax rate is 31%. If the risk-free rate is 3.34%, the market;risk premium is 7%, and the company?s beta is 0.7, what should the stock sell;for based on a discounted valuation of its projected dividends? (10 points);Q 4.;You have hit it rich.;Oil has been discovered on the land that you inherited from your Grandma;in Southern Indiana. After tense;negotiations with Evansville Oil Extraction Inc.?s lawyer (Dewey, Cheatem;Howe), you have agreed to receive 15 years of monthly royalty payments of;$3,000 per month from the Oil Company.;Because it will take a little time to get the oil rig in place, the;first of the monthly royalty payments will be paid exactly 18 months from;now. If the interest rate implicit in;the agreement is 3.36% APR, compounded monthly, what is the present value of;the royalty agreement that you have made?;(10 points);Q 5.;Greenfield Manufacturing has hired you to estimate its cost;of capital for new investment decisions.;The firm has 1,600,000 shares of common stock outstanding that are;trading for $38.75 per share. The;company?s beta is 0.87. The rate on;30-year t-bonds (risk free rate) is currently 3.34%. The market risk premium is 7%. Greenfield has an average tax rate of 32.5%;and a marginal tax rate of 35%.;Greenfield?s bonds have a 7.25% coupon rate, a $1,000 face value, pay;semi-annual coupons, and mature in 9 years.;There are 32,000 of these bonds that are outstanding and they are;currently selling in the open market for $1,023.35. What is Greenfield?s Weighted Average Cost of;Capital (WACC)? (12 points).;Q 6.;Suppose two all equity-financed firms, Firm X and Firm Y;are considering the same new project that has a beta of 0.6. The project has an IRR of 9.5%. Firm X has a beta of 1.2 and Firm Y has a;beta of 0.8. The risk-free rate is 4%;and the expected market risk premium 8%.;Which firm(s) should take the project?;Clearly explain. (8 points).;Part 2;Q7;It is May of 2014, and Krushenski Industries is examining a;capital investment proposal that involves the replacement of a wheel-a-brator;that was purchased only 4 years ago, but is nonetheless relatively inefficient;compared to newer models.;Company Background;Krushenski Industries was established in the early 1970s for;the purpose of manufacturing and forging high quality steel products with a;specialized niche in the production of custom forgings for the agricultural;construction, earth- moving equipment, and heavy brake industries. Krushenski also developed a standard;proprietary forged product line comprised of yokes and clevises manufactured to;the Society of Automotive Engineer's Specifications. Krushenski has the advantage of in-house;forging and heat-treating departments, which allowed Krushenski to develop a;variety of innovative forged products.;Within a few years, the company was distributing forged products across;the country.;In the 1970s and 1980s, major suppliers of the trucking;industry such as Bendix, Rockwell International, and Bristol began to;out-source many components to independent forging companies such as Krushenski;Industries. The company entered into;this new area by forging slack-adjusters, S-cams, and compressor crankshafts;for the above- mentioned companies. In;addition, Krushenski Industries forged components for large construction;equipment producers such as Caterpillar and John Deere. With this new influx of business, Krushenski;shifted its strategy away from its proprietary product line and focused;attention on forging products for companies considered "heavy;industry". Thus, Krushenski today;is a supplier of forged components to numerous heavy industry manufacturers who;prefer to sublet the forging and tooling parts of their production;process.;Replacement Decision;Should the wheel-a-brator be replaced?;The wheel-a-brator in place was purchased 4 years ago for;$127,000. When purchased, it had an;estimated useful life of 13 years. The;depreciation charges for the old wheel-a-brator are based on the 7-yr MACRS;schedule. Ian Smith, the company?s;industrial engineer, recently confirmed that the old wheel-a-brator has;approximately 9 years of remaining service left if it is not replaced. If it is to be replaced, the existing;wheel-a-brator can now be sold for approximately $18,000. If the existing wheel-a-brator is kept for;the remaining 9 years of its useful life, it will be worthless at the end of;nine years.;If a new wheel-a-brator is purchased now, it would cost the;company $246,000. Expectations are that;the new larger and more efficient wheel-a-brator would produce an annual;pre-tax cost savings (relative to the wheel-a-brator in place) of $50,000 per;year for the duration of its expected useful life of 9 years. Though it has an expected useful life of 9;years, the new wheel-a-brator would also be depreciated according to the 7-year;MACRs schedule. Assume that the new;machine will be sold for a scrap value of $15,000 at the end of 9 years. This replacement proposal will have no effect;on net working capital investments.;Aubrey Williams, the firm?s accountant, points out that the;portion of the factory that would house the new wheel-a- brator underwent a;major ?renovation? last year with a total cost of $45,000. Because the installation of the new;wheel-a-brator would not have been feasible without the renovation, Aubrey;contends that the costs of the renovation should be allocated as one of the;replacement project?s initial ?expenses?.;Aubrey also estimates that interest charges associated with the purchase;of the new wheel-a-brator would average $6,000 per year over the equipment?s;9-year expected life.;The CFO of Krushenski Industries (Cesar Dominguez) requests;your assistance in preparing an analysis of the net cash flow projections for;the immediate replacement of the wheel-a-brator. In particular, Cesar is interested in the net;present value and IRR of the replacement decision, along with your;recommendation based on these figures.;Cesar has informed you to use the company?s 12% cost of capital as the;discount rate for this project and a tax rate of 35%. (40 POINTS);Use the following MACRs Schedule for the purpose of;determining the depreciation charges.;7-year MACRS Schedule;Year;Depreciation;1 14.29%;2 24.49%;3 17.49%;4 12.49%;5 8.93%;6 8.92%;7;8.93%;8 4.46%


Paper#49744 | Written in 18-Jul-2015

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