# Capital Budgeting Questions

## Question

1. How much will you have at the end of 22 years if put \$6,800 per year at the end of each year into a saving account earning 8.0% annually? _________

2. How much do you need to invest today (once) to have \$89,000 at the end of 19 years if you can earn 3.5% annually? ____________

3. Assume that you have accumulated \$60,000 in student loan debt. You pick an 18-year horizon to pay of the loan. If the loan has a 5.5% annual rate, what will your monthly payments be? _________________

4. A bond can be purchased for \$985 today. This bond pays \$72 in interest each year in annual year end payments. The bond has a par or maturity value of \$1,000 and has 9 years to maturity. What is the expected yield to maturity for this bond? (Two decimal places please – for example 8.25%)_______________

5. A different bond pays 6.5% annual interest once per year, has 9 years to maturity, and a \$1,000 par or maturity value. Given the risk level of this bond the market demands a 8.2% interest rate. What is the value of this bond today?_______________

6. Joe Inc.’s preferred stock is expected to pay a \$1.43 dividend annually and is expected to do this forever. Joe Inc. is in a high risk business that requires an 8% return. What is the estimated value of Joe Inc.’s preferred stock?_______________

7. Bill Inc. common stock is expected to pay a \$1.32 dividend at the end of the year and is in a risk class that requires an 8% required return. If this dividend is expected to grow forever at a 4% rate, what is the estimated value of Bill Inc.’s common stock? _______________

8. Joe’s Technology must choose between two repeatable methods of producing a new product. The initial costs and year-end cash benefits are as follows:
Year 0 1 2 3 4 5
Method M -\$1,500,000 600,000 750,000 500,000 200,000
Method N -\$2,500,000 1,200,000 900,000 700,000 400,000 300,000

Assume all cash flows occur at year-end and the company’s required return is 5.5 percent.
Please compute the net present value ______________ and the equivalent annuity ________________ for Method M
Please compute the net present value ______________ and the equivalent annuity ________________ for Method N

Which production method should be used? _______________

9. You are put in charge of replacing the fleet of sales and executive automobiles for your company. Three types of cars have been identified. The first type would cost less upfront, have higher maintenance cost, and lower salvage values after shorter lives. The second type would cost a little more upfront, have slightly lower maintenance cost, and slightly higher salvage values after slightly longer operating lives. The third type would cost more upfront, have lower maintenance cost, and higher salvage values after longer operating lives. The cash flow estimates for each type is given below:
Type one: Purchase price per car \$16,000; Annual operating expense per car \$4,000; Disposition value per car \$4,000; Estimated useful life of the car 4 years
Type two: Purchase price per car \$32,000; Annual operating expense per car \$3,600; Disposition value per car \$5,500; Estimated useful life of the car 6 years
Type three: Purchase price \$48,000; Annual operating expense \$2,800; Disposition value \$8,000; Estimated useful life of the asset 8 years

All cars can be replaced at the end of their asset lives. Using a 6.3 percent discount rate and the equivalent annuity method, which car is the better investment? Please show the NPV, and Equivalent annuity for each type of car.
NPV Equivalent Annuity
Car Type One ____________________ _____________
Car Type Two ____________________ _____________
Car Type Three ____________________ _____________

Which type of car should be chosen?______________________

10. An asset costs \$247,000 and will generate cash benefits of \$80,000 at the end of each year for six years for Hartford Corporation. Salvage values are \$160,000, \$145,000, \$85,000, and \$45,000 at the end of years 3, 4, 5, and 6 respectively. The required return is 5.25 percent.
Please compute the net present value, and the equivalent annuity and record these below:
Keep for 6 years ________________ ____________________
Keep for 5 years ________________ ____________________
Keep for 4 years ________________ ____________________
Keep for 3 years ________________ ____________________
When is the optimal time to abandon the investment?_____________________

11. You place a commercial building into service on February 28th, 2012 costing \$2,200,000. What is the depreciation expense allowed by the IRS for this building for tax years 2012? _____________And 2013?______________

12. You place the following equipment into service in the following years with the following tax lives:
Year placed Tax life Cost
Into service
Computer 2011 3 year \$17,000
Car 2012 5 year \$25,000
Shelves 2013 7 year \$34,000

What is the total depreciation expense allowed by the IRS for all three pieces of equipment for tax years 2012?__________________

What is the total depreciation expense allowed by the IRS for all three pieces of equipment for tax years 2013?__________________

What is the total depreciation expense allowed by the IRS for all three pieces of equipment for tax years 2014?__________________

13. You are opening your own business and estimate the following expenses and revenues:
Year 1 Year 2 Year 3
Revenues \$900,000 \$1,300,000 \$1,100,000
Cost of goods sold \$550,000 \$800,000 \$700,000

Accounts payable as a percentage of cost of goods sold……..11%
Inventory as a percentage of cost of goods sold……………...13%
Cash balance as a percentage of revenues……………..……..8%
Accounts receivables as a percentage of revenues…………...15%
Accrued expenses as a percentage of revenues……..………..9%
All balances are needed in the year prior to the generation of the revenue and expense.
Please calculate the incremental investment in working capital needed for years 0,1,2,3. (you do not need to calculate the cash flow from operations – you do not have enough information to do this – only the incremental investment in working capital – all working capital accounts are liquidated at book value at the end of year 3)

Year 0_______________ Year 1_______________ Year 2__________________ and Year 3______________

Able Corporation has Project A with the following cash flows and a 6.7% cost of money: Numbers in parentheses are outflows. Both Year 0 and Year 3 cash flows are outflows.
Year 0 1 2 3 4 5 6
Cash flow \$(312,000) \$ 95,000 \$120,000 \$(280,000) \$ 230,000 \$200,000 \$180,000

14. Please calculate the net present value ______________

16. Please calculate the modified profitability index using the terminal value approach in the textbook (two decimals please)_______________________

18. Please calculate the modified internal rate of return (two decimals please and per the book)________________________

21. You are opening your own business and estimate the following expenses and revenues:
Revenues year 1 \$210,000 growing at 9% thereafter
Cost of goods sold year 1 \$121,000 growing at 10% thereafter
Operating expense year 1 \$47,000 growing at 6% thereafter
Taxes all in years 20% per year
Depreciation \$15,000 in year 1, \$21,000 in year 2, \$17,000 in year 3

No working capital is needed -- please predict the after-tax cash flows from operations for the first three years of operations below:

Year 1_______________ Year 2__________________ and Year 3______________

## Solution Preview

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1. How much will you have at the end of 22 years if put \$6,800 per year at the end of each year into a saving account earning 8.0% annually? __\$7,317____

2. How much do you need to invest today (once) to have \$89,000 at the end of 19 years if you can earn 3.5% annually? __\$46,282______

3. Assume that you have accumulated \$60,000 in student loan debt. You pick an18-year horizon to pay of the loan. If the loan has a 5.5% annual rate, what will your monthly payments be? ___\$438.18________...
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