FIN 534 Homework Set #4
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Use the following information for
Questions 6 through 8:
The staff of Porter Manufacturing
has estimated the follo
wing net after
–
tax cash flows and probabilities for
a new manufacturing process:
Line 0 gives the cost of the
process, Lines 1 through 5 give operating cash flows, and Line 5* contains the
estimated salvage values. Porter’s
cost of capital for an average
–
r
isk project is 10%.
Net After
–
Tax Cash Flows
Year
P = 0.2
P = 0.6
P = 0.2
0
−$100,000
−$100,000
−$100,000
1
20,000
30,000
40,000
2
20,000
30,000
40,000
3
20,000
30,000
40,000
4
20,000
30,000
40,000
5
20,000
30,000
40,00
0
5*
0
20,000
30,000
6.
Assume that the project has average
risk. Find the project’s expected NPV. (Hint: Use expected
values for the net cash flow in each
year.)
7.
Find the best
–
case and worst
–
case NPVs. What is the probability
of occurr
ence of the worst case
if the cash flows are perfectly
dependent (perfectly positively correlated) over time?
8.
Assume that all the cash flows are
perfectly positively correlated. That is, assume there a
re 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 deviation, and its
coefficient of variation
for each probability
.
Use the following information for
Ques
tion 9:
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 35% in 2014. Total assets
and accounts payable are
proportional to s
ales, and that relationship will be
maintained. Wallace typically
uses no current liabilities 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 s
tock in
2014 to meet some of its financing
needs. The remainder of its financing needs will be met by issuing
new long
–
term debt at the end of 2014.
(Because the 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 5%, and 45% of
earnings will be paid out as
dividends.
9.
What were Wallace’s total long
–
term debt and total liabilities in
2013?
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