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FIN311 - Class Assignment #3




Question;Burton;a manufacturer of snowboards, is considering replacing an existing piece of;equipment with a more sophisticated machine. The following information is;given.;The proposed machine will cost $120,000 and have installation;costs of $15,000. It will be depreciated;using a 3 year MACRS recovery schedule.;It can be sold for $60,000 after three years of use (at the end of year;3).The existing machine was purchased two years ago for $90,000;(including installation). It is being;depreciated using a 3 year MACRS recovery schedule. It can be sold today for $20,000. It can be used for three more years, but;after three more years it will have no market value.The earnings before taxes and depreciation (EBITDA) are as;follows:New machine: Year 1: 133,000, Year 2: 96,000, Year 3: 127,000Existing machine: Year 1: 84,000, Year 2: 70,000, Year 3: 74,000Burton;pays 40 percent taxes on ordinary income and capital gains. They expect;a large increase in sales so their Net Working Capital will increase by $20,000.;Calculate;the initial investment required for this projectDetermine;the incremental operating cash flowsFind;the terminal cash flow for the project;Burton;has determined its optimal capital structure, which is composed of the;following sources and target market value proportions.Debt: Burton can;sell a 15-year, $1,000 par value, 8 percent annual coupon bond for $1,050. A;flotation cost of 2 percent of the face (par) value would be required.;Additionally, the firm has a marginal tax rate of 40 percent.Common Stock: Burton's;common stock is currently selling for $75 per share. The dividend expected to;be paid at the end of the coming year is $5. Its dividend payments have been;growing at a constant 3% rate. It is;expected that to sell all the shares, a new common stock issue must be;underpriced $2 per share and the firm must pay 1% of market value per;share in flotation costs.;Calculate;the after-tax cost of debtCalculate;the cost of equity (for new common stock issues);Calculate the WACC;Burton;wants to determine if replacing their machine will benefit their shareholders;(see #1). They believe the cash flows;are somewhat uncertain and adjust for risk using a RADR. For the level of risk they will be taking;they prefer using a RADR of 10%.;Calculate;the NPV and IRR using Burton?s cost of capital (see #2).Calculate;the NPV and IRR using the RADR.Should;they purchase the new machine? Why or;why not?;Burton has established a target capital structure of 40;percent debt and 60 percent common equity. The firm expects to earn $600 in;after-tax income during the coming year, and it will retain 40 percent of those;earnings. The current market price of the firm's stock is P0 = $75;its last dividend was D0 = $4.85, and its expected dividend growth;rate is 3 percent. Burton can issue new common stock at a 15 percent flotation;cost. What will Burton's marginal cost of equity capital (not the WACC);be if it must fund a capital budget requiring $600 in total new capital?


Paper#50118 | Written in 18-Jul-2015

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