a Part 5 Corporate Valuation and Governance Easy Problems 1-3 (,,'Lt AfN ESeEisr-I laz-2) AFN Equation la24) AFN Equation Intermediate Problems 4-6 $2-41 Sales Increase (12-s) 'Long-Term Financing Needed Broussard Skateboard's sales are expected to increase by l5o/o from $8 million in 2013 to $9.2 million in 2014. Its assets totaled $5 million at the end 0f 2013. Broussard is already at firll capacity, so its assets must grow at the same rate as projected sales. At the end o{ 2013, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 5o/o, and the forecasted payout ratio is 40%o. Use the AFN equation to forecast Broussard's additional funds needed for the coming year. Refer to Problem 12-1. \Yhat would be the additional funds needed if the company's year- end 2013 assets had been $7 million? Assume that all other numbers, including sales, are the same as in Problem 12-1 and that the company is operating at fi.rll capacity. Why is this AFN different from the one you found iu Problem 12-1? Is the company s "capital intensity" ratio the same or different? Refer to Problem 12-1. Returrr to the assumption that the company had $5 million in assets at the end of 2013, but now assume that the company pay$ no dividends. Under these assumptions, what would be the additional funds needed for the coming year? Why is this AFN difilerent from the one you found in Problem 12-i? Maggie's Muffins, Inc., generated $5,000,000 in sales during 2013, and its year-end total assets were $2,500,000. Also, at year-end 2013, current liabilities were $1,000,000, consisting of $300,000 of notes payable, $500,000 of accounts payable, and $200"000 of accruals. Looking ahead to 2014, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 7%, and. its payout ratio will be 80%. How large a sales increase can the company achieve without having to raise funds externally-that is, lvhat is its self- supporting growth rate? At year-end 2013, Wallace Landscaping's total assets were $2.17 million and its accounts payable were $560,000. Sales, which in 2013 were $3.5 million, are expected to increase by 35o/o in 2014. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Wallace fypically uses no culrent iiabilities other than accounts payable. Common stock amounted to $625,000 in 2013, and retained earnings were $395,000. Wallace has arranged to sell $195,000 of new common stock in 2014 to meet some of its financing needs. The remainder of its financing needs wiil be met by issuing new long-term debt at the end pf 2A14. (Because &e debt is added at the end of the year, there will be no additional interest expense due to the new debt.) Its net profit margin on sales is .

1. a
Part 5 Corporate Valuation and Governance
Easy Problems 1-3
(,,'Lt
AfN ESeEisr-I
laz-2)
AFN Equation
la24)
AFN Equation
Intermediate
Problems 4-6
$2-41
Sales Increase
(12-s)
'Long-Term Financing
Needed
Broussard Skateboard's sales are expected to increase by l5o/o
from $8 million in
2013 to $9.2 million in 2014. Its assets totaled $5 million at the
end 0f 2013.
Broussard is already at firll capacity, so its assets must grow at
the same rate as

2. projected sales. At the end o{ 2013, current liabilities were $1.4
million, consisting
of $450,000 of accounts payable, $500,000 of notes payable,
and $450,000 of
accruals. The after-tax profit margin is forecasted to be 5o/o,
and the forecasted
payout ratio is 40%o. Use the AFN equation to forecast
Broussard's additional funds
needed for the coming year.
Refer to Problem 12-1. Yhat would be the additional funds
needed if the company's year-
end 2013 assets had been $7 million? Assume that all other
numbers, including sales, are
the same as in Problem 12-1 and that the company is operating
at fi.rll capacity. Why is
this AFN different from the one you found iu Problem 12-1? Is
the company s "capital
intensity" ratio the same or different?
Refer to Problem 12-1. Returrr to the assumption that the
company had $5 million in
assets at the end of 2013, but now assume that the company
pay$ no dividends. Under
these assumptions, what would be the additional funds needed
for the coming year? Why
is this AFN difilerent from the one you found in Problem 12-i?
Maggie's Muffins, Inc., generated $5,000,000 in sales during
2013, and its year-end total
assets were $2,500,000. Also, at year-end 2013, current
liabilities were $1,000,000,

3. consisting of $300,000 of notes payable, $500,000 of accounts
payable, and $200"000 of
accruals. Looking ahead to 2014, the company estimates that its
assets must increase at the
same rate as sales, its spontaneous liabilities will increase at the
same rate as sales, its
profit margin will be 7%, and. its payout ratio will be 80%.
How large a sales increase can
the company achieve without having to raise funds externally-
that is, lvhat is its self-
supporting growth rate?
At year-end 2013, Wallace Landscaping's total assets were
$2.17 million and its
accounts payable were $560,000. Sales, which in 2013 were
$3.5 million, are expected
to increase by 35o/o in 2014. Total assets and accounts payable
are proportional to
sales, and that relationship will be maintained. Wallace
fypically uses no culrent
iiabilities other than accounts payable. Common stock amounted
to $625,000 in 2013,
and retained earnings were $395,000. Wallace has arranged to
sell $195,000 of new
common stock in 2014 to meet some of its financing needs. The
remainder of its
financing needs wiil be met by issuing new long-term debt at
the end pf 2A14.
(Because &e debt is added at the end of the year, there will be
no additional interest
expense due to the new debt.) Its net profit margin on sales is
57o, and 45Vo of
earnings will be paid out as dividends.

4. a. What were Mallace's total long-term debt and total liabilities
in 2013?
b. How much new long-term debt financing will be needed in
2014? (Hizr: AFN -
New stock = New long-term debt.)
(11-2)
Operating Cash FIow
(x1-3)
Net Salvage Value
(11-4)
Replacement
Analysis
Intermediate
Problems 5-11
(11-s)
Depreciation
Methods
F1-6)
New-Project Analysis
Part 4 Projects and Their Valuation

5. The financial staff of Cairn Communications has identified the
following information for
the first year of the roll-out ofits new proposed seryice:
Projected sales $18 million
Operating costs (not including depreciation) $ 9 million
Depreciation
Interest expense
$ 4 mition
$ 3 million
The company faces a 40o/o tax rate. What is the project's
operating cash flow for the fust
year (t = 1)?
Allen Ak Lines must liquidate some equipment that is being
replaced. The equipment
originally cost $12 million, of which 75o/ohas been depreciated.
The used equipment can
be sold today for $4 rnillion, and its tax rate is 40Yo. What is
the equipment's after-tax net
salvage value?
Although the Chen Company's milling machine is old, it is still
in relatively good working
order and would last for another l0 years. It is inefficient
compared to modem standards,
though, and so the company is considering replacing it. The new
milling machine, at a
cost of $110,000 delivered and instalied, would also last for 10
years and would produce
after-tax cash flows (labor savings and depreciation tax savings)
of $19,000 per year. It

6. would have zero salvage value at the end of its life. The firm's
WACC is 107o, and its
marginal tax rate is 357o. Should Chen buy the new machine?
Wendy's boss wants to use straight-line depreciation for the new
expansion project
because he said it will give higher net income in earlier years
and give him a larger bonus.
The project will last 4 years and requires $1,700,000 of
equipment. The company could
use either straight line or the 3-year MACRS accelerated
method. Under straight-line
depreciation, the cost of the equipment would be depreciated
evenly orrer its 4-year life
(ignore the half-year convention for the straight-line method).
The appiicable MACRS
depreciation rates are 33.33%,44.45%, l4.8lo/o, and"7.4lo/o, as
discussed in Appendix 11A.
The company's WACC is 10%, and its tax rate is 40%.
a. What would &e depreciation expense be each year under each
method?
b. Which depreciation method would produce the higher NPV,
and how much higher
would it be?
c. Why might Wendy's boss prefer straight-line depreciation?
The Campbell Company is considering adding a robotic paint
sprayer to its
production line. The sprayer's base price is $1,080,000, and it
would cost another
$22,500 to install it. The machine falls into the MACRS 3-year
class, and it would be
sold after 3 years for $605,000. The MACRS rates for the first
three years are 0.3333,

7. 0.4445, and 0.1481. The machine would require an increase in
net working capital
(inventory) of $15,500. The sprayer would not change revenues,
but it is expected to
save the firm $380,000 per year in before-tax operating costs,
mainly labor.
Campbell's marginal tax rate is 357o.
a. What is the Year 0 net cash flow?
b. What are the net operating cash flows in Years 1, 2, and 3?
c. What is the additional Year-3 cash flow (i.e., the after-tax
salvage and the return of
working capital)?
d. If the project's cost of capital is 127o, should the machine be
purchased?
-
Chapter I 1 Cash Flow llstimation and Risk Analysis
year 3. The earth mover would have no effect on revenuesr but
it is expected to save the
firm $20,000 per year in before-tix operating costs, mainly
labor. The finn's marginal
federal-plus-state tax rate is 407o-
a. What are the Year-0 cash flows?
b. What are the operating cash flows in Years 1,2' and 3?
c. What are the additional (nonoperating) cash flows in Year 3?

8. d. If the project's cost of capital is 10%, should the earth mover
be purchased?
The staff of Porter Manufacturing has estimated the follorving
net after-tax cash tlows and
probabilities for a new manufacturing Process:
Net After-Tax Cash Flows
Year P = 0.2 P=0.6 P=0.2
{sr-2)
Corporate Risk
Analysis
0 -$100,000
I 20,000
2 20,000
3 20,000
4 20,000
5 20,000
5*0
-$100,000 -$ 100,000
30,000 40,000
30,000 40,000
30,000 40,000
30,000 40,000
30,000 40,000
20,000 30,000
Line 0 gives the cost of the process, Lines 1 through 5 give
operating cash flows, and

9. Line 5* contains the estimated salvage values. Porter's cost of
capital for an average-risk
project is 107o.
a. Assume that the project has average risk. Find the project's
expected NPV. (Hinf: Use
expected values for the net cash flow in each year.)
b. Find the best-case and worst-case NPVs. What is the
probability of occurrence of the
..t/orst case if the cash flows are perfectly dependent (perfectly
positively correlated)
over time? If they are independent over time?
c. Assume that all the cash flows are perfectly positively
correlated. That is, assume
there are only three possible cash flow streams over time-the
worst case, the most
likely (or base) case, and the best case-with respective
probabilities of 0'2, 0.6, and
0.2. These cases are represented by each of the columns in the
table. Find the
expected NPV, its standard deyiation, and its coefficient of
variation.
Easy Problems 1-4
(11'4
Investment OutlaY

10. Talbot Industries is considering launching a new product. The
new manufacturing
equipment will cost $17 million, and production and sales will
require an initial $5 million
investment in net operating working capital. The company's tax
rate is 40Yo.
a. What is the initial investrnent outlay?
b. The company spent and expensed $150,000 on research
related to the new product
last year. Would this change your answer? Explain.
c. Rather than build a new manufacturing facility, the company
plans to install the
equipment in a building it owns but is not now using. The
building could be sold for
$i.S miilion after taxes and real estate commissions. How would
this affect your
answer?
i:r.t*rrrirrliai*
Ir nl:iE;r:r: &*1i4
(10-8)
NPVs, IRRs, and
MIRRs for Indepen-

11. dent Projects
tLo-e)
NPVs and IRRs for
Mutually Exclusive
Projects
{10-10}
Capital Budgeting
Methods
(10-11)
MIRR and NPV
Part 4 Projects and Tireir Valuation
Edelman Engineering is considering including two pieces of
equipment a truck and an
overhead pulley system, in this year's capital budget. The
projects are independent. The
cash outlay for the truck is $i7,100 and that for the pulley
system is $22,430. The firm's
cost of capital is 14%. After-tax cash flows, including
depreciation, are as follows:
Year Truck Pulley
1
2
J

12. 4
q
$5,100
5,100
5,100
5,'100
5,100
$7,500
7,500
7,500
7.500
7,500
Calculate the IRR, the NPV, and the MIRR for each project, and
indicate the correct
accept-reject decision for each.
Davis Industries must choose between a gas-powered and an
electric-powered forklift
truck for moving materials in its factory. Because both forklifts
perform the same
function, the firm will choose only one. (They are mutually
exclusive investments.) The
electric-powered nrrck will cost more, but it will be less
expensive to operate; it will cost
$22,000, whereas the gas-powered truck will cost $17,500. The

13. cost of capital that applies
to both investrnents is l2Vo. The life for both qryes of truck is
estimated to be 6 years,
during which time the net cash flows for the electric-powered
truck will be $6,290 per year
and those for the gas-powered truck will be $5,000 per year.
Annual net cash flows include
depreciation expenses. Calculate the NPV and IRR for each type
of truch and decide
which to recommend.
Project S has a cost of $10,000 and is expected to produce
benefits (cash flows) of $3,000
per year for 5 years. Project L costs $25,000 and is expected to
produce cash flows of
$7,400 per year for 5 years. Calculate the two projects' NPVs,
IRRs, MIRRs, and PIs,
assuming a cost of capital af l2o/o. Which project would be
selected, assuming they are
mutually exclusive, using each ranking method? Which should
actually be selected?
Your company is considering two mutually exclusive proiects,
X and Y, whose costs and
cash flows are shown below:
Year
0
1
2
3

14. 4
-$5,ooo
1,000
1,500
2,000
4,000
-$5,000
4,500
1,500
1,000
500
The projects are equally ris$, and their cost of capital ts 12a/a.
You must make a
recommendation, and you must base it on the modified IRR
(MIRR). Which project has
the higher MIRR?
i . i After discovering a new gold vein in the Colorado
mountains, CTC Mining Corporation
NPV and IRR Analysis must decide whether to go ahead and
develop the deposit" The most cost-effective rnethod of
mining gold is sulfuric acid extraction, a process that could
result in environmental damage.

15. Chapter I 0 The Basics of Capital Budgeting: Evaluating Cash
Fiows
Expected Net Cash Flows
Project X Project Y
0
1
2
3
4
+10,000
6,500
3,000
3,000
1,000
*$10,000
3,500
3,500
3,500
3,500

16. a. Calculate each project's payback period, net present value
(NPV), internal rate
of return (IRR), modified internal rate of return (MIRR), and
profitability
index (PI).
b. Which project or projects should be accepted if they are
independent?
c. Which project should be accepted if they are mutuaily
exclusive?
d. Horv inight a change in the cost of capital produce a conflict
between the NPV and
IRR rankings of these two projects? Would this conflict exist if
r were 5%? (Hint: Plot
the NPV profiies.)
e. Why does the conflict exist?
(10-1)
NPV
(10-2)
IRR
(10-3)
MIRR
(10-4)
Profitability Index
(10-s)

17. Payback
(10-6)
Discounted Payback
$o-7)
NPV
A project has an initial cost of $40,000, expected net cash
inflows of $9,000 per year for 7
years, and a cost of capital of l1o/o. What is the project's NPV?
(Hirf: Begin by
constructing a time line.)
Refer to Problem l0-1. What is the project's IRR?
Refer to Problem l0-1. What is the project's MIRR?
Refer to Problem 10-1. What is the project's PI?
Refer to Problem l0-1. What is the project's payback period?
Refer to Problem 10-1. What is the project's discounted payback
period?
Your division is considering rwo investnrent projects, each of
which requires an up-front
expenditure of $15 million. You estimate that the investments
will produce the following
net cash flows:
Proiect BYear Project A
1

18. 2
a
What are the two projects' net
10o/o?. lio/a?
What are the two projects' IRRs
present values, assuming the cost of capital is 5o/o?
at these same costs of capital?
$ 5,000,000
10,000,000
20,000,000
$20,000,000
10,000,000
6,000,000
PRO B L E M S Answers Appearin AppendixB
a
Chapter 9 The Cost of Capital 389
Easy Pr*biems t-8

19. (e-1)
After-Tax Cost of
Debt
p4
After-Tax Cost of
Debt
(e-3)
Cost of Preferred
Stock
(e-4)
Cost of Preferred
Stock with Flotation
Costs
(c's
Cost ofEquity: DCF
(e-6)
Cost of Equity: CAPM
t9_l
wAcc
te-8)
urncc

20. Intermediate
Problems $-14
(s-e)
Bond Yield and
After-Tax Cost of
Debt
(e-10)
Cost of Equity
Calculate the after-tax cost of debt under each of the following
conditions:
3. r.1 of 139/0, tax rate of 0%
b. r,1 of 13%, tax rate of 207o
c. 16 of 137o, tax rate of 35%
LL Incorporated's currently outstanding 1l7o coupotl bonds
have a yieid t<-r maturitl'of
BVo. LL believes it could issue new bonds at par that would
provide a similar yield to
maturity. If its marginal tax rate is 35%, what is LL's after-tax
cost of debt?
l)uggins Veterinary Supplies can issue perpetual preferred stock
at a price of $-i0 a share
Iqith an annual dividend of $4.50 a share. Ignoring flotation
costs, what is the company's
cost of preferred stock, r*,,?

21. Burnwood Tech plans to issue some $60 par preferred stock
with a 67o dividend. A similar
stock is selling on the market fcrr $70. Burnwood must pay
fiotation costs of 57o of the
issue price. What is the cost of the preferred stock?
Surnmerdahl Resort's common stock is currently trading at $36
a share. The stock is
expecred to pay a dividend of $3.00 a share at the end of the
year (Dr = $3.00), and the
dividend is expected to grow at a constant rate of 5o/o a year.
What is its cost of common
equity?
Booher Book Stores has a beta of 0.8. The yield on a 3-rnonth
T-bill is 4o/o, and the yield
on a 10-year T-bond is 6%. The market risk premium is 5.5%,
and the return on an
average stock in the rnarket last year was l5%. What is the
estimated cost of common
equity using the CAPM?
Shi Impofiers's balance sheet shows $300 million in debt, $50
million in preferred stock, and
$250 million in total common equity. Shi's tax rate is 407o, ta=
60/o, rr.. = 5.8%, and r" = 1270.
If Shi has a target capital structure of 30% debt, 5% preferred

22. stock, and 6570 common stock,
what is its WACC?
David Ortiz Motors has a target capital structure of 40% debt
and 60% equtty. The yield to
maturitv on the cornpany's outstanding bonds ls 9%' and the
companlr's tax rate is 407o'
Ortiz's CFO has calculated the company's WACC as9.960,/o.
What is tl're company's cost of
equif capitai?
A company's 6% coupon rate, semiannual palnrrent, $1,000 par
value hond that matures
in 30 years sells at a price of 5515.16. The company's federal-
plus-state tax rate is 40%'
What is the tirm's after-tax conlponent cost of debt for purposes
of calculating the
WACC? (Hint:Base your answer on the nominal rate.)
The earnings, dividends, and stock price of Shelby Inc. are
expected to grow al 7o/a per
year in the future. Shelb,v's common stock sells for $23 per
share, its last dividend rvas
$2.00, and the company will pay a dividend of 1i2.14 at the end
of the current year.
a. Using the discounted cash flow approach, rvhat is its cost of
equity?
b. If the finn's beta is 1.6, the risk-free rate is 9%, and the

23. expected return on the
mar-ket is 13%, then what would be the firm's cost of equity
based on the CAPM
approach?