AGEC 424 Third Hour Exam Fall 2013 (100 Points)

AGEC 424 Third Hour Exam Fall 2013 (100 points)

Name______

You must show logically correct work, including calculator inputs and outputs for all problems to receive credit. Show signs on calculator inputs. Differentiate calculator outputs from inputs.

1.  (6 points) Provide the missing information for the following projects. Show calculator inputs and output in the space provided.

Project Initial Length Annual Cost of NPV

Investment (in years) Cash Flow Capital

A $100,000 5 $35,000 8% “a”

B $200,000 4 “b” 13% $35,000

C $300,000 7 $50,000 “c” $15,000

a. b. c.

2.  (2 points) Cost of capital is the appropriate discount rate in capital budgeting when:

3.  (2 points) Scenario/Sensitivity analysis is a procedure that can be used in the capital budgeting process to indicate how sensitive the _____ is to changes in a particular variable.

4.  (4 points) Sanville Quarries is considering acquiring a new drilling machine which is expected to be more efficient than their current machine. The project is to be evaluated over four years. The initial outlay required to get the new machine operating is $675,000. Incremental cash flows associated with the machine are uncertain, so management developed the following probabilistic forecast of cash flows by year ($000). Sanville’s cost of capital is 10%.

Year1 Prob Year2 Prob Year3 Prob Year4 Prob

$150 .30 $200 .35 $350 .30 $300 .25

$175 .40 $210 .45 $370 .25 $360 .35

$300 .30 $250 .20 $400 .45 $375 .40

a. What is the NPV of the expected (mean) cash flows? Show Work.

5.  (16 points) Bagel Pantry Inc. is considering two mutually exclusive projects with widely differing lives. The company's cost of capital is 12%. The project cash flows are summarized as follows:

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b. Compare the projects by using Payback. Which project(s) has the best payback, why?

c. Based on the EAA method (show EAA calculation), which project(s) would you select, why?

d. If the projects were independent instead of mutually exclusive, which would you chose and why?

Questions 7 and 8 are on the last page and you may remove that page from the exam.

Question 7

Question 8

New Investment

6.  (30 points) Mars Inc. is considering the purchase of a new machine, which will reduce manufacturing costs by $40,000 annually. Mars will use 3-year MACRS (percentages: 33, 45, 15, 7) to depreciate the machine, and it expects to sell the machine at the end of its 3year operating life for $20,000. The firm expects to be able to reduce net working capital by $5,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 3 years. Mars' marginal tax rate is 40 percent, and it uses a 12 percent required rate of return to evaluate projects of this nature. If the machine costs $100,000, determine the cash flows, payback, NPV, and IRR on the attached sheet. Recommend either acceptance or rejection and say why.

Replacement Problem:

7.  (40 points) Meals on Wings Inc. supplies prepared meals for corporate aircraft (as opposed to public commercial airlines), and it needs to purchase new broilers. If the broilers are purchased, they will replace old broilers purchased 10 years ago for $105,000 and which are being depreciated on a straight line basis to a zero salvage value for tax purposes (15year depreciable life). The old broilers can be sold today for $60,000, but will have only a $10,000 market value in 3 years. The new broilers will cost $100,000 installed and will be depreciated using MACRS over their 3year class life (percentages in problem above); they will be sold at twice their book value at the end of the 3rd year. The firm expects to increase its revenues by $33,000 per year if the new broilers are purchased, but cash expenses will also increase by $3,000 per year. The firm's required rate of return is 10 percent and its tax rate is 40 percent. Determine the cash flows, NPV, and IRR on the attached sheet. Recommend either acceptance or rejection and say why.

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