Transcribed Text
1) Vornado Realty Trust (VNO), a New York based REIT. is evaluating six real estate
Management plans to buy the properties today and sell them five years from today
The following table summarizes the initial cos and the expected sale price for each property,
as
well as the appropriate discount rate based on the risk feach venture.
VNO has total capital budget of $18,000,000 invest in properties.
Project
Cost
Discount
Expected Sale
IRR
NPV
Profitability
Rate
Price in Year 5
Index
Sussex
$3M
15%
$18M
?
?
?
Ridge
Orchard
$15M
15%
$75.5M
?
?
?
Estates
Lakeville
$9M
15%
$50M
?
?
?
Seaside
$6M
8%
$35.5M
?
?
?
Greenville $3M
8%
$10M
?
?
?
Westlake $9M
8%
$46.5M
?
?
?
a. What the IRR of each investment?
b. What the NPV of each investment?
c.
Given its budget of $18,000,000. which properties should VNO choose (use the profitability
index)?
d. Explain why the profitability index method could not be used if NNO's budget were
12,000,000 instead Which properties should KP choose this case?
2) International Paper (IP). based paper onglomerant is considering expanding its
production capacity by purchasing newmachine. the TJ-50 The cost the TJ-750 is
million Unfortunately installing this machine several months partially disrupt
production The firm has just completed $50,000 feasibility study analyze the decision to
buy the TJ-50 resulting the following estimates:
. Marketing: Once the TJ 50 operating next year the extra capacity expected to
merate $10 million per year in additional sales, which will continue for the 0-year life of
the machine
Operations: The disruption caused by the installation will decrease sales by $5 million this
year Once th machine operating next year. the cost goods for the products produced
TJ-50i expected tre be 70% of their sale price The increased roduction will
require addi tional inventory on hand million obe added year and depleted year
10.
.
Human Resources: The expansion will require additional sales and administrative personnel
at
cost 2 million year.
. Accounting: The TJ-50 lbe depreciated via the straight- line method over the 10 -year
life machine The firm expectsreceivables from the new sales to be 15% revenues
payables obe 10% the cost of goods sold IP's marginal corporate tax rate
35%
a. Determine the incremental earnings from the purchase the TJ-50
b. Determine free cash flow from the purchase the
If the appropriate cost capital for the expansion 10% compute the NPV of the
purchase.
d While the expected new sales will $10 million per year from the expansion estimates
range from million $12 million What NPV in the worst case? the best case?
What even level of new sales from the expansion? What is the break -even level
for
the cost of
goods
sold?
could purchase the .90. which offers even greater capacity The cost
TJ-90 i million. would not be useful irst two years of
operation but would allow for additional sales years -10. What level additional sales
(abovet $10 million expected for the year those years would justify
purchasing the larger machine?
3) Keystone Industries an automobile manufacturer Management is currently evaluating
proposal build 1 manufac lightweight trucks Keystone plans
:
capital of 12% this project Based research, it has prepared the following
incremental free cash flow projections (in millions dollars):
Year 0
Years 1-9
Year
Revenues
100.0
100.0
Manulacturing expenses
(other depreciation)
36.0
35.0
Marketing expenses
-10.0
-10.0
Depreciation
-15.0
15.0
EBIT
40.0
40.0
Taxes (36%)
-14.0
-14.0
Unlevered income
26.0
26.0
+
Depreciation
+15.0
+15.0
Increases warking
5.0
5.0
Capital expenditures
150.0
+ Continuation value
+12.0
Free cash flow
-150.0
36.0
48.0
a. For this base-case scenario, what the NPV of the plant omanucture lightweight trucks?
b Based input from the marketing department Keystone uncertain abou its revenue
forecast particular anagement would like examine the sensitivity NPV tothe
revenue assumptions Whati the NPV project frevenues 10% higher than
forecast? What s the NPV frevenues are 10% lower than forecast?
c. Rather than assuming that cash flows for this project are constant, mana gement would
like
explore sensitivity of its analysis possible growth revenues and operating
expenses Specifically. management would like to assume that revenues ufacturing
expenses, and marketing expenses are given the table for year and grow 2%per
year every year starting year Management also plans assume initial capital
expenditures therefore depreciation). additions working capital. and continuation
value remain initially specified i the table. Whatis the NPV this project under these
alternative assumptions? How does the NPV change the revenues and operating expenses
grow by 5% per year rather than by 2%?
4)The night before important budget meeting, you are reviewing the project valuation analysis
you had your summer intern prepare for one the projects be discussed:
2
3
4
ERIT
10.0
10.0
10.0
Interest (5%)
-4.0
-4.0
-3.0
-2.0
Earnings Before Taxes
8.0
Taxes
preciation
26.0
25.0
25.0
25.0
Cap
-100.0
NWC
-20.0
20.0
Net Deb.
80.0
0.0
-20.0
-20.0
40.0
FCFE
40.0
28.6
8.6
9.2
9.8
NPV Equity Cost Capital
5.9
Looking over the spreadsheet you realize that while all of the cash flow estimates are correct,
your associate used flow-to-equity valuation method discounted cash flow using
the
equity cost capital 11% However the project incremental leverage very
different from the company historical debt -qquity ratie of 0.20: For this project, company
will instead borrow $80 million upfront and repay $20 million year million year
and $40 million year 4 Thus, project equity capital likely higher than
the
firm's constant over time- invalidating your associate calculation Clearly. FTE
approach is not the best way analyze this project. Fortunately. you have your calculator
with
you. and with any luck you can use abetter method before the meeting starts.
What the present value fthe interest tax shield associated with this project?
b.
What
the
free
cash
flows o
project?
c. Whati the best estimate of the project' value from the information given?
5) Sports Unlimited expected to generate free cash flows of $10.9 million per vear. THe has
permanent debt $40 million, tax 40% and an unlevered 10% (15%)
Whati the value of their equity using the APV method?
What WACC? What their equity value using the WACC method?
c. IXXL sdebt cost 5% what is their equity cost capital?
d. What their equity value using the FTE method?
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