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# 12-1

## Chapter 12 Capital-Budgeting Decisions

Methods of Financing
12.1
(a) Equity financing:

Let X denote the number of shares to be sold. The total flotation cost would be

(0.06)(\$25) X \$1.5 X

## To net \$10 million,

25 X 1.5 X \$10,000,000
23.5 X \$10,000,000
X 425,532 shares
Flotation cost = \$1.5(425,532) = \$638,298

## (b) Debt financing:

\$10, 000, 000
Flotation cost = \$10, 000, 000 \$193, 680
1 0.019
Number of bond = \$10,193,680 / \$1,000 = 10,194 units
Annual interest = (10,194) (\$1,000) (0.12) = \$1,223,280

12.2 *
(a) Equal repayment of the principal:

Repayment
n Loan Balance
Interest Principal
0 \$300,000
1 \$36,000 \$50,000 \$250,000
2 \$30,000 \$50,000 \$200,000
3 \$24,000 \$50,000 \$150,000
4 \$18,000 \$50,000 \$100,000
5 \$12,000 \$50,000 \$50,000
6 \$6,000 \$50,000 \$0

## n Repayment Loan Balance

*
An asterisk next to a problem number indicates that the solution is available to students
on the Companion Website.

12-2

Interest Principal
0 \$300,000
1 \$36,000 \$0 \$300,000
2 \$36,000 \$0 \$300,000
3 \$36,000 \$0 \$300,000
4 \$36,000 \$0 \$300,000
5 \$36,000 \$0 \$300,000
6 \$36,000 \$300,000 \$0

## A \$300, 000( A / P,12%, 6) \$72,968

Repayment
n Loan Balance
Interest Principal
0 \$300,000
1 \$36,000 \$36,968 \$263,032
2 \$31,564 \$41,404 \$221,628
3 \$26,595 \$46,372 \$175,256
4 \$21,031 \$51,937 \$123,319
5 \$14,798 \$58,169 \$65,150
6 \$7,818 \$65,150 \$0

12.3
(a) Equity financing
End of Year 0 1 2 3 4
Income Statement
Revenues/Savings \$100,000 \$100,000 \$100,000 \$100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Taxable income 70,000 49,000 64,300 75,010
Income taxes (35%) 24,500 17,150 22,505 26,254
Net Income \$45,500 \$31,850 \$41,795 \$48,757

## Cash Flow Statement

Operating activities
Net income \$45,500 \$31,850 \$41,795 \$48,757
CCA 30,000 51,000 35,700 24,990
Investment activities
Investment and Salvage (200,000) 30,000
Disposal tax effects 9,909
Net cash flow (\$200,000) \$75,500 \$82,850 \$77,495 \$113,655
3
UCC4 = \$200,000(0.85)(0.7) = \$58,310 ; G= (\$58,310 - 30,000)(0.35) = \$9,909

12-3

PW(10%) = \$72,958
AE(10%) = \$23,016

## (b) Debt financing

End of Year 0 1 2 3 4
Income Statement (Bank
A)
Revenues/Savings \$100,000 \$100,000 \$100,000 \$100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Interest (10%) 20,000 15,000 10,000 5,000
Taxable income 50,000 34,000 54,300 70,010
Income taxes (35%) 17,500 11,900 19,005 24,504
Net Income \$32,500 \$22,100 \$35,295 \$45,507

## Cash Flow Statement

Operating activities
Net income \$32,500 \$22,100 \$35,295 \$45,507
CCA 30,000 51,000 35,700 24,990
Investment activities
Investment and Salvage (200,000) 30,000
Disposal tax effects 9,909
Financing
Loan repayment 200,000 (50,000) (50,000) (50,000) (50,000)
Net cash flow \$0 \$12,500 \$23,100 \$20,995 \$60,405
4
UCC5 = \$200,000(0.85)(0.7) = \$58,310 ; G= (\$58,310 - 30,000)(0.35) = \$9,909

PW(10%) = \$87,486
AE(10%) = \$27,599

End of Year 0 1 2 3 4 5
Income Statement
Revenues/Savings \$100,000 \$100,000 \$100,000 \$100,000
Expenses
CCA 30,000 51,000 35,700 24,990
Interest (10%) 20,000 16,724 13,121 9,157 4,796
Taxable income 50,000 32,276 51,179 65,853 (4,796)
Income taxes (35%) 17,500 11,297 17,913 23,049 (1,679)
Net Income \$32,500 \$20,979 \$33,267 \$42,805 (3,118)

## Cash Flow Statement

Operating activities

12-4

## Net income \$32,500 \$20,979 \$33,267 \$42,805 (3,118)

CCA 30,000 51,000 35,700 24,990
Investment activities
Investment and Salvage (200,000) 30,000
Disposal tax effects 9,909
Financing
Loan repayment 200,000 (32,759) (36,035) (39,639) (43,603) (47,963)
Prepayment (46,437)
Net cash flow \$0 \$29,741 \$35,944 \$29,328 \$17,663 (51,081)
UCC5 = \$200,000(0.85)(0.7)4 = \$58,310 ; G= (\$58,310 - 30,000)(0.35) =
\$9,909

PW(10%) = \$90,841
AE(10%) = \$28,658

Comments: The project terminates after four years where the bank financing from
Bank B extends over five years. Since the bank financing is related to the proposed
project, any unpaid future expenses after the project must be charged against the
revenue from the proposed project. This adjustment is shown under the
prepayment in the amount of \$46,437, which is the equivalent cost in year 4 for
the future expense (net cash flow) in the amount of \$51,081 at the firms MARR.

## (c) Best course of action: Adopt Bank Bs repayment plan

12.4
(a) The total flotation costs to raise \$65 million:

Common stock:
Amount of common stock (\$65, 000, 000)(0.45)
\$29, 250, 000
\$29, 250, 000
Flotation cost = \$29, 250, 000 \$1, 410,377
1 0.046

Preferred stock:
Amount of preferred stock (\$65, 000, 000)(0.10)
\$6,500, 000
\$6,500, 000
Flotation cost = \$6,500, 000 \$572,905
1 0.081

Bond:
Amount of bond (\$65, 000, 000)(0.45)
\$29, 250, 000
\$29, 250, 000
Flotation cost = \$29, 250, 000 \$425,314
1 0.014

12-5

## (b) Number of shares or (bonds) to be sold to raise \$65 million:

Common stock:
X S (1 0.046)(\$32) \$29, 250, 000
X S 958,137 shares

Preferred stock:
X P (1 0.081)(\$55) \$6,500, 000
X P 128,598 shares

Bond:
X B (1 0.014)(\$980) \$29, 250, 000
X B 30, 271 units

## (c) Cash requirement to meet financing costs:

Common stock:
Annual cash dividends (\$2 / share)(958,137 shares)
\$1,916, 274
Preferred stock:
Annual cash dividends (0.06)(\$15 / share)(128,598shares)
\$115, 738

Bond:
Borrowing amount (30, 271)(\$1, 000)
\$30, 271, 000
Annual interest = (\$30,271,000)(0.12) = \$3,632,520

## Total annual cash requirement = \$5,664,532

Cost of Capital
12.5 After-tax cost of debt:

(a)
(0.12)(1 0.25) 0.09 or 9%

(b)
(0.14)(1 0.34) 0.0924 or 9.24%

12-6

(c)
(0.15)(1 0.40) 0.09 or 9%

12.6 In the absence of bond maturity date, we need to assume that the 13% yield to
maturity represents the before-tax cost of debt after considering both the
flotation cost as well as bond discounting. Let kb 13% . Then we compute the
after-tax cost of debt as follows:

## 12.7 Cost of retaining earnings:

\$1
kr 0.12 17.56%
\$18

12.8
(a) Flotation costs in percentage:
15
fc 1 16.67%
18

## (b) Cost of new common stock:

\$1.10
ke 0.10 18.80%
\$15(1 0.1667)

12.9
ie 0.22
id (0.13)(1 0.40) 0.078
k (0.078)(0.45) (0.22)(0.55)
0.1561

## ie (55 / 70)(0.30) (15 / 70)(0.12) 0.2614

id (1 0.40)[(0.3333)(0.14) (1 0.3333)(0.12)] 0.07602
k (0.07602)(0.30) (0.2614)(0.70)
0.2058

*
12.11
Given: ie 18%, id (0.12)(1 0.36) 0.0768

## k (0.4)(0.0768) (0.6)(0.18) 13.87%

12-7

(a) Net equity flow method: PW (18%) \$36,306 0 , accept the project.

End of Year 0 1 2 3 4 5
Income Statement
Revenue \$90,000 \$90,000 \$90,000 \$90,000 \$90,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000
Interest payment 9,600 8,089 6,396 4,501 2,378
CCA 30,000 51,000 35,700 24,990 17,493
Taxable income 40,400 20,911 37,904 50,509 60,129
Income taxes (36%) 14,544 7,528 13,645 18,183 21,647
Net Income \$25,856 \$13,383 \$24,258 \$32,326 \$38,483

## Cash Flow Statement

Operating activities
Net income \$25,856 \$13,383 \$24,258 \$32,326 \$38,483
CCA 30,000 51,000 35,700 24,990 17,493
Investment activities
Investment and Salvage (200,000) 50,000
Disposal tax effects (3,306)
Financing activities
Borrowed funds 80,000
Principal repayment (12,593) (14,104) (15,796) (17,692) (19,815)
Net cash flow (\$120,000) \$43,263 \$50,279 \$44,162 \$39,624 \$82,855

(b) Cost of capital method: PW (13.87%) \$41, 704 0 , accept the project.

End of Year 0 1 2 3 4 5
Income Statement
Revenue \$90,000 \$90,000 \$90,000 \$90,000 \$90,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000
CCA 30,000 51,000 35,700 24,990 17,493
Taxable income 50,000 29,000 44,300 55,010 62,507
Income taxes (36%) 18,000 10,440 15,948 19,804 22,503
Net Income \$32,000 \$18,560 \$28,352 \$35,206 \$40,004

## Cash Flow Statement

Operating activities
Net income \$32,000 \$18,560 \$28,352 \$35,206 \$40,004
CCA 30,000 51,000 35,700 24,990 17,493

12-8

## Investment and Salvage (200,000) 50,000

Disposal tax effects (3,306)
Net cash flow (\$200,000) \$62,000 \$69,560 \$64,052 \$60,196 \$104,192

12.12
(a) Net equity flow method:

End of Year 0 1 2 3 4 5
Income Statement
Revenue \$45,000 \$45,000 \$45,000 \$45,000 \$45,000
Expenses
Interest payment 9,000 7,665 6,130 4,365 2,335
CCA 15,000 25,500 17,850 12,495 8,747
Taxable income 21,000 11,835 21,020 28,140 33,919
Income taxes (30%) 6,300 3,550 6,306 8,442 10,176
Net Income \$14,700 \$8,284 \$14,714 \$19,698 \$23,743

## Cash Flow Statement

Operating activities
Net income \$14,700 \$8,284 \$14,714 \$19,698 \$23,743
CCA 15,000 25,500 17,850 12,495 8,747
Investment activities
Investment and Salvage (100,000) 30,000
Disposal tax effects (2,877)
Financing activities
Borrowed funds 60,000
Principal repayment (8,899) (10,234) (11,769) (13,534) (15,564)
Net cash flow (\$40,000) \$20,801 \$23,551 \$20,795 \$18,659 \$44,048
PW 20% \$32, 423
ie 20%, id (0.15)(1 0.30) 0.105
(b) Cost of capital method:
k (0.60)(0.105) (0.40)(0.20) 14.30%

End of Year 0 1 2 3 4 5
Income Statement
Revenue \$45,000 \$45,000 \$45,000 \$45,000 \$45,000
Expenses
CCA 15,000 25,500 17,850 12,495 8,747
Taxable income 30,000 19,500 27,150 32,505 36,254
Income taxes (30%) 9,000 5,850 8,145 9,752 10,876
Net Income \$21,000 \$13,650 \$19,005 \$22,754 \$25,377

## Cash Flow Statement

12-9

Operating activities
Net income \$21,000 \$13,650 \$19,005 \$22,754 \$25,377
CCA 15,000 25,500 17,850 12,495 8,747
Investment and Salvage (100,000) 30,000
Disposal tax effects (2,877)
Net cash flow (\$100,000) \$36,000 \$39,150 \$36,855 \$35,249 \$61,247

PW 14.3% \$38,189
12.13
(a) Using ie 15% : Select Machine B.
Machine A
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue \$20,000 \$20,000 \$20,000 \$20,000 \$20,000 \$20,000
Expenses
O&M 8,000 8,000 8,000 8,000 8,000 8,000
Interest payment 1,200 1,044 873 685 478 250
CCA \$6,000 \$10,200 \$7,140 \$4,998 \$3,499 \$2,449
Taxable income 4,800 756 3,987 6,317 8,023 9,300
Income taxes (35%) 1,680 264 1,395 2,211 2,808 3,255
Net Income \$3,120 \$491 \$2,591 \$4,106 \$5,215 \$6,045

## Cash Flow Statement

Operating activities
Net income \$3,120 \$491 \$2,591 \$4,106 \$5,215 \$6,045
CCA 6,000 10,200 7,140 4,998 3,499 2,449
Investment activities
Investment and Salvage (40,000) 4,000
Disposal tax effects 600
Financing activities
Borrowed funds 12,000
Principal repayment (1,555) (1,711) (1,882) (2,070) (2,277) (2,505)
Net cash flow (\$28,000) \$7,565 \$8,980 \$7,849 \$7,034 \$6,437 \$10,590

PW(15%) = \$2,329
Machine B
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue \$28,000 \$28,000 \$28,000 \$28,000 \$28,000 \$28,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000 10,000

12-10

## Interest payment 1,800 1,567 1,310 1,028 717 376

CCA \$9,000 \$15,300 \$10,710 \$7,497 \$5,248 \$3,674
Taxable income 7,200 1,133 5,980 9,475 12,035 13,951
Income taxes (35%) 2,520 397 2,093 3,316 4,212 4,883
Net Income \$4,680 \$737 \$3,887 \$6,159 \$7,823 \$9,068

## Cash Flow Statement

Operating activities
Net income \$4,680 \$737 \$3,887 \$6,159 \$7,823 \$9,068
CCA 9,000 15,300 10,710 7,497 5,248 3,674
Investment activities
Investment and Salvage (60,000) 8,000
Disposal tax effects 200
Financing activities
Borrowed funds 18,000
Principal repayment (2,333) (2,566) (2,823) (3,105) (3,416) (3,757)
Net cash flow (\$42,000) \$11,347 \$13,470 \$11,774 \$10,551 \$9,655 \$17,184

PW(15%) = \$4,056

(b) Using k 0.31 0.35 0.1 0.7 0.15 12.45% : Select machine B.

Machine A
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue \$20,000 \$20,000 \$20,000 \$20,000 \$20,000 \$20,000
Expenses
O&M 8,000 8,000 8,000 8,000 8,000 8,000
CCA \$6,000 \$10,200 \$7,140 \$4,998 \$3,499 \$2,449
Taxable income 6,000 1,800 4,860 7,002 8,501 9,551
Income taxes (35%) 2,100 630 1,701 2,451 2,975 3,343
Net Income \$3,900 \$1,170 \$3,159 \$4,551 \$5,526 \$6,208

## Cash Flow Statement

Operating activities
Net income \$3,900 \$1,170 \$3,159 \$4,551 \$5,526 \$6,208
CCA 6,000 10,200 7,140 4,998 3,499 2,449
Investment activities
Investment and Salvage (40,000) 4,000
Disposal tax effects 600
Net cash flow (\$40,000) \$9,900 \$11,370 \$10,299 \$9,549 \$9,025 \$13,257

12-11

PW(12.45%) = \$2,587

Machine B
End of Year 0 1 2 3 4 5 6
Income Statement
Revenue \$28,000 \$28,000 \$28,000 \$28,000 \$28,000 \$28,000
Expenses
O&M 10,000 10,000 10,000 10,000 10,000 10,000
CCA \$9,000 \$15,300 \$10,710 \$7,497 \$5,248 \$3,674
Taxable income 9,000 2,700 7,290 10,503 12,752 14,326
Income taxes (35%) 3,150 945 2,552 3,676 4,463 5,014
Net Income \$5,850 \$1,755 \$4,739 \$6,827 \$8,289 \$9,312

## Cash Flow Statement

Operating activities
Net income \$5,850 \$1,755 \$4,739 \$6,827 \$8,289 \$9,312
CCA 9,000 15,300 10,710 7,497 5,248 3,674
Investment activities
Investment and Salvage (60,000) 8,000
Disposal tax effects 200
Net cash flow (\$60,000) \$14,850 \$17,055 \$15,449 \$14,324 \$13,537 \$21,186

PW(12.45%) = \$4,523

## (c) Both methods provide consistent solutions.

Capital Budgeting
12.14 Based on the investment opportunity curve below, the firms optimal capital
budget would be \$177 million, with no restriction on the firms debt limit.
However, with a budget limit of \$100 million, the firm may select Projects 5
and 3 first. Since these two projects alone consume \$95 million, the firm may
have two choices about utilizing the remaining \$5 million funds. First choice is
to find any projects whose rates of return exceed the cost of capital. Project 4
comes close to meeting this requirement. However, the firms borrowing rate is
18%, which is greater than the rate of return from Project 4. Therefore, the
projects that should be included in the \$100 million budget would be Projects 5
and 3. If money has to be raised from outside, the firm should raise only \$95
million.

Rate of Return

12-12

90%
5 80%
3

40%
2 32% 30%

7 6 22%
1 15% Borrowing rate (18%)
4
Lending (12%)

12.15
(a) Present worth analysis: With no budget restriction, select alternatives 1, 2, 3, 4,
7, 13, and 14. The total NPW from the projects is \$2,194.

j PW(8%) j PW(8%)
1 \$303 8 -\$208
2 \$500 9 -\$165
3 \$661 10 -\$27
4 \$46 11 -\$1,017
5 -\$66 12 -\$248
6 -\$814 13 \$126
7 \$47 14 \$512
(b) With a budget limit of \$1,800, select alternatives 1, 2, 3, 4, 13, and 14. The
total amount of investment required is \$1,756.

## Short Case Studies

ST 12.1 Their financial data for Year 2010:

## Number of Shares 1,000,000

Long-Term Debts 12,000,000
Interest Paid 1,200,000
Assets 5,000,000
Earning before Tax 3,500,000

## * Stock Price per Share 18 Total Equity 18,000,000

* Earning per Share 2.1 Total Earning 2,100,000

12-13

## (b) From the table, the tax rate is

\$2,100, 000
1 0.4
\$3,500, 000

(c)
MARR with known source of financing = Cost of equity
Increase in share price over the four years plus the dividends each year, divided
by the starting share price:

1
(18 8) 1.1 1.2 1.5 1.9 4
ie 1 18.36%
8

## Cost of Debt 10% (40% of assets)

Cost of Equity 18.36% (60% of assets)
Tax Rate 40%

## k (0.1 (1 0.4) 0.4) (0.1836 0.6) 13.42%

(d) Assuming that the company funds the new project by maintaining the same
debt to equity ratio. To raise the \$10,080,00 needed (for equipment and
installation), they have to borrow \$4,032,000 and issue 336,000 stocks (at \$18
per share), which will increase their equity \$6,048,000 for the project. At 11%,
the flotation costs of \$665,280 are deducted as an expense.

End of Year 0 1 2
Income Statement
Revenue \$44,000,000 \$44,000,000
Cost of Goods Sold 35,200,000 26,400,000
Interest 403,200 403,200
CCA \$1,512,000 \$2,570,400
Taxable income 6,884,800 14,626,400
Income taxes (40%) 2,753,920 5,850,560
Net Income \$4,130,880 \$8,775,840

12-14

## Cash Flow Statement

Operating activities
Net income \$4,130,880 \$8,775,840
CCA 1,512,000 2,570,400
Investment activities
Investment and Salvage (10,080,000) 3,600,000
Disposal tax effects 959,040
Finance 4,032,000 (4,032,000)
Stock issue fee (\$665,280)
Net cash flow (\$6,713,280) \$5,642,880 \$11,873,280
NPW (18.36%) 6,529,815

## (18, 000, 000 6,529,815)

Most likely stock price = \$18.36 / share
(1, 000, 000 336, 000)shares

(e) Three different ways to finance the project are considered. In case of debt
financing, the interests are at the end of each year and the principal is fully
repaid in a lump sum at the end of the fifth year. Based on the analyses, the
potential stock price of each case would be as follows:

## 100% Equity Current Mixed 100% Debt

Methods
Financing Financing Financing
Stock price 39.86 48.03 67.15

12-15

## 100% Equity Financing

End of Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000
Cost of Goods Sold 35,200,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000
Interest
CCA \$1,512,000 \$2,570,400 \$1,799,280 \$1,259,496 \$881,647 \$617,153 \$432,007 \$302,405
Taxable income 7,288,000 15,029,600 15,800,720 16,340,504 16,718,353 16,982,847 17,167,993 17,297,595
Income taxes (40%) 2,915,200 6,011,840 6,320,288 6,536,202 6,687,341 6,793,139 6,867,197 6,919,038
Net Income \$4,372,800 \$9,017,760 \$9,480,432 \$9,804,302 \$10,031,012 \$10,189,708 \$10,300,796 \$10,378,557

## Cash Flow Statement

Operating activities
Net income \$4,372,800 \$9,017,760 \$9,480,432 \$9,804,302 \$10,031,012 \$10,189,708 \$10,300,796 \$10,378,557
CCA 1,512,000 2,570,400 1,799,280 1,259,496 881,647 617,153 432,007 302,405
Investment activities
Investment and
Salvage (10,080,000)
Disposal tax effects
Finance
Stock issue fee (\$1,108,800)
Net cash flow (\$11,188,800) \$5,884,800 \$11,588,160 \$11,279,712 \$11,063,798 \$10,912,659 \$10,806,861 \$10,732,803 \$10,680,962
Discounted to time 0 (\$11,188,800) \$4,971,979 \$8,271,983 \$6,802,848 \$5,637,604 \$4,698,059 \$3,930,837 \$3,298,346 \$17,753,139
PW(18.36%) = \$44,175,997

## (18, 000, 000 44,175,997)

Stock price = \$39.86/share
(1, 000, 000 560, 000)shares

12-16

## Current Mixed Financing

End of Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000
Cost of Goods Sold 35,200,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000
Interest 403,200 403,200 403,200 403,200 403,200
CCA \$1,512,000 \$2,570,400 \$1,799,280 \$1,259,496 \$881,647 \$617,153 \$432,007 \$302,405
Taxable income 6,884,800 14,626,400 15,397,520 15,937,304 16,315,153 16,982,847 17,167,993 17,297,595
Income taxes (40%) 2,753,920 5,850,560 6,159,008 6,374,922 6,526,061 6,793,139 6,867,197 6,919,038
Net Income \$4,130,880 \$8,775,840 \$9,238,512 \$9,562,382 \$9,789,092 \$10,189,708 \$10,300,796 \$10,378,557

## Cash Flow Statement

Operating activities
Net income \$4,130,880 \$8,775,840 \$9,238,512 \$9,562,382 \$9,789,092 \$10,189,708 \$10,300,796 \$10,378,557
CCA 1,512,000 2,570,400 1,799,280 1,259,496 881,647 617,153 432,007 302,405
Investment activities
Investment and
Salvage (10,080,000)
Disposal tax effects
Finance 4,032,000 (4,032,000)
Stock issue fee (\$665,280)
Net cash flow (\$6,713,280) \$5,642,880 \$11,346,240 \$11,037,792 \$10,821,878 \$6,638,739 \$10,806,861 \$10,732,803 \$10,680,962
Discounted to time 0 (\$6,713,280) \$4,767,584 \$8,099,293 \$6,656,945 \$5,514,333 \$2,858,074 \$3,930,837 \$3,298,346 \$17,753,139
PW(18.36%) = \$46,165,273

## (18, 000, 000 46,165, 273)

Stock price = \$48.03 / share
(1, 000, 000 336, 000)shares

12-17

## 100% Debt Financing

End of Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000 \$44,000,000
Cost of Goods Sold 35,200,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000 26,400,000
Interest 1,008,000 1,008,000 1,008,000 1,008,000 1,008,000
CCA \$1,512,000 \$2,570,400 \$1,799,280 \$1,259,496 \$881,647 \$617,153 \$432,007 \$302,405
Taxable income 6,280,000 14,021,600 14,792,720 15,332,504 15,710,353 16,982,847 17,167,993 17,297,595
Income taxes (40%) 2,512,000 5,608,640 5,917,088 6,133,002 6,284,141 6,793,139 6,867,197 6,919,038
Net Income \$3,768,000 \$8,412,960 \$8,875,632 \$9,199,502 \$9,426,212 \$10,189,708 \$10,300,796 \$10,378,557

## Cash Flow Statement

Operating activities
Net income \$3,768,000 \$8,412,960 \$8,875,632 \$9,199,502 \$9,426,212 \$10,189,708 \$10,300,796 \$10,378,557
CCA 1,512,000 2,570,400 1,799,280 1,259,496 881,647 617,153 432,007 302,405
Investment activities
Investment and
Salvage (10,080,000)
Disposal tax effects
Finance 10,080,000 (10,080,000)
Stock issue fee
Net cash flow \$0 \$5,280,000 \$10,983,360 \$10,674,912 \$10,458,998 \$227,859 \$10,806,861 \$10,732,803 \$10,680,962
Discounted to time 0 \$0 \$4,460,993 \$7,840,259 \$6,438,090 \$5,329,426 \$98,097 \$3,930,837 \$3,298,346 \$17,753,139
PW(18.36%) = \$49,149,187

## (18, 000, 000 49,149,187)

Stock price = \$67.15 / share
(1, 000, 000)shares

12-18

ST 12.2
(a) There are 36 mutually exclusive alternatives without considering the budget
and engineering-hour constraints. Projects 1 and 2 are mutually exclusive
projects; Projects 5 and 6 or keeping the current supplier are mutually
exclusive; Project 3 is contingent on Project 2.

## 1 1,5 1,7 1,4,6 1,5,7 1,4,5,7

2 2,5 2,7 2,4,6 2,5,7 2,4,5,7
2,3 2,3,5 2,3,7 2,3,4,6 2,3,5,7 2,3,4,5,7
1,4 1,6 1,4,5 1,4,7 1,6,7 1,4,6,7
2,4 2,6 2,4,5 2,4,7 2,6,7 2,4,6,7
2,3,4 2,3,6 2,3,4,5 2,3,4,7 2,3,6,7 2,3,4,6,7

(b) There are 10 feasible alternatives with the budget and time restrictions:

1 1 6 2,6
2 2 7 2,7
3 1,4 8 1,4,7
4 1,5 9 1,5,7
5 1,7 10 2,6,7

(c) Without knowing the exact cash flow sequences for each project over the
project life, it is not feasible to determine the optimal capital budget.

ST 12.3
(a) Select A and C with FW(10%) = \$4,894. Since \$500 is left over after selecting
A and C, we could lend out the leftover funds at 10% for three periods.
Therefore, the total amount available for lending at the end of period 3 is
calculated as follows:
F \$4,894 \$500( F / P,10%,3)
\$5,559.60
(b) Select B and C. The total amount available for lending at the end of period 3 is
\$5,740.

(c) With a budget limit of \$3,500, the reasonable MARR should be the lending
rate of 10%. (You select A and C and have \$500 available for lending.)

ST 12.4
(a) The debt repayment schedule for the loan from the equipment manufacturer:

Loan Repayment
n Loan Balance
Interest Principal
0 \$2,000,000
1 \$200,000 \$125,491 \$1,874,509
2 \$187,451 \$138,040 \$1,736,469

12-19

## 3 \$173,647 \$151,844 \$1,584,625

4 \$158,463 \$167,028 \$1,417,597
5 \$141,760 \$183,731 \$1,233,866
6 \$123,387 \$202,104 \$1,031,762
7 \$103,176 \$222,315 \$809,447
8 \$80,945 \$244,546 \$564,901
9 \$56,490 \$269,001 \$295,901
10 \$29,590 \$295,901 \$0
(b) The flotation costs and the number of common stocks to raise \$8,500,000:

\$8,500, 000
Flotation cost = \$8,500, 000 \$749,184
1 0.081

\$8,500, 000
Number of shares = 205,537 shares
(1 0.081)(\$45)

(c) The flotation costs and the number of \$1,000 bonds to raise \$10.5 million:

\$10,500, 000
Flotation cost = \$10,500, 000 \$203,364
1 0.019

\$10,500, 000
Number of bonds = 11,893units
(1 0.019)(\$900)

12-20

ST 12.5 (a) The net cash flow from the cogeneration project with bond financing
End of Year 0 1 2 3 4 5 6 7 8 9 10 11 12
(all units in thousands of dollars)
Income Statement
Revenue
Electricity bill \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0
Excess power 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0
Expenses
O&M 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0
Misc. 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0
Standby Power 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4
Fuel 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0
Overhauls 1,600.0 1,600.0 1,600.0
CCA on Unit 500.0 950.0 855.0 769.5 692.6 623.3 561.0 504.9 454.4 408.9 368.0 331.2
CCA on Inter. Equip. 75.0 127.5 89.3 62.5 43.7 30.6 21.4 15.0 10.5 7.4 5.1 3.6
Interest (9%) 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4 1,070.4
Taxable income 2,168.23 1,665.73 198.98 1,911.26 2,006.95 489.32 2,160.84 2,223.36 678.35 2,326.94 2,370.04 2,408.38
Income taxes (36%) 780.56 599.66 71.63 688.05 722.50 176.16 777.90 800.41 244.21 837.70 853.21 867.02
Net Income 1,387.67 1,066.07 127.35 1,223.20 1,284.45 313.17 1,382.93 1,422.95 434.14 1,489.24 1,516.82 1,541.37

## Cash Flow Statement

Operating activities
Net income \$1,388 \$1,066 \$127 \$1,223 \$1,284 \$313 \$1,383 \$1,423 \$434 \$1,489 \$1,517 \$1,541
CCA on Unit 500 950 855 770 693 623 561 505 454 409 368 331
CCA on Inter. Equip. 75 128 89 62 44 31 21 15 11 7 5 4
Investment and Salvage
Unit (10,000) 975
Inter Equip. (500) 25

12-21

## Disposal tax effects 716

Loan/repayment 10,500 (11,893)
Net cash flow \$0 \$1,963 \$2,144 \$1,072 \$2,055 \$2,021 \$967 \$1,965 \$1,943 \$899 \$1,906 \$1,890 (\$8,301)
PW(27%) = \$5,629.625 thousands
(b) The maximum annual lease amount that ACC is willing to pay is \$909.528. (By Excel goal.)

End of Year 0 1 2 3 4 5 6 7 8 9 10 11 12
(all units in thousands of dollars)
Income Statement
Revenue
Electricity bill \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0 \$6,120.0
Excess power 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0 480.0
Expenses
O&M 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0 500.0
Misc. 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0
Standby Power 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4
Fuel 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0 1,280.0
Overhauls 1,600.0 1,600.0 1,600.0
Lease 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5 909.5
Taxable income 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 1,304.07 2,904.07 2,904.07 2,904.07
Income taxes (36%) 1,045.47 1,045.47 469.47 1,045.47 1,045.47 469.47 1,045.47 1,045.47 469.47 1,045.47 1,045.47 1,045.47
Net Income 1,858.61 1,858.61 834.61 1,858.61 1,858.61 834.61 1,858.61 1,858.61 834.61 1,858.61 1,858.61 1,858.61

## Cash Flow Statement

Operating activities
Net income \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$1,859
Net cash flow \$0 \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$835 \$1,859 \$1,859 \$1,859
PW(27%) = \$5,629.625 thousands