Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming yearWhich project(s) should Maloney undertake during the upcoming year if it has only $6,000,000 of funds available?
Answer(s): C
With only $6,000,000 available and each project costing $4,000,000 or more, no more than one project can be undertaken. Project 1 should be chosen because it has a positive NPV and the highest profitability index. The high profitability index means that the company will achieve the highest NPV per dollar of investment with Project 1.The profitability index facilitates comparison of different-sized investments.
Mercken Industries is contemplating four projects, Project P, Project Q, Project P, and Project S. The capital costs and estimated after-tax net cash flows of each mutually exclusive project are listed below. Mercken's desired after-tax opportunity cost is 12%, and the company has a capital budget for the year of $450,000. Idle funds cannot be reinvested at greater than 12%.During this year, Mercken will choose
Only two of the projects can be selected because three would require more than $450,000 of capital. Project S can immediately be dismissed because it has a negative net present value (NPV). Using the NPV and the profitability index methods, the best investments appear to be 0 and P. The internal rate of return (IPP) method indicates that P is preferable to P. However, it assumes reinvestment of funds during Years 4 and 5 at the lRR (18.7%). Given that reinvestment will be at a rate of at most 12%, the IPP decision criterion appears to be unsound in this situation.
Mercken Industries is contemplating four projects, Project P, Project Q, Project P, and Project S. The capital costs and estimated after-tax net cash flows of each mutually exclusive project are listed below. Mercken's desired after-tax opportunity cost is 12%, and the company has a capital budget for the year of $450,000. Idle funds cannot be reinvested at greater than 12%.If Mercken is able to accept only one project, the company would choose
Answer(s): B
Because unused funds cannot be invested at a rate greater than 12%, the company should select the investment with the highest net present value. Project Q is preferable to P because its return on the incremental $45000 invested ($235,000 cost of Q--$190,000 cost of P) is greater than 12%.
The method that recognizes the time value of money by discounting the after-tax cash flows over the life of a project, using the company's minimum desired rate of return is the
The net present value (NPV) method computes the discounted present value of future cash inflows to determine whether they are greater than the initial cash outflow. The discount rate (cost of capital or hurdle rate) must be known to discount the future cash inflows. If the NPV is positive (present value of future cash inflows exceeds initial cash outflow), the project should be accepted. If the NPV is negative, the project should be rejected.
Mulva Inc. is considering the following five independent projects:The company has a target capital structure which is 40 percent debt and 60 percent equity. The company can issue bonds with a yield to maturity of 10 percent. The company has $900000 in retained earnings, and the current stock price is $40 per share. The flotation costs associated with issuing new equity are $2 per share. Mulva's earnings are expected to continue to grow at 5 percent per year. Next year's dividend (D1) is forecasted to be $2.50. The firm faces a 40 percent tax rate. What is the size of Mulva's capital budget?
The size of Mulva's capital budget will be determined by the number of projects it can profitably undertake, i.e., those projects for which the IRR is greater than the applicable weighted average cost of capital.First, the cost of each type of capital must be determined. The formula for calculating the cost of retained earnings is ks = (D1 + Po) + G, where D equals the dividend after year one, P0 equals the current stock price, and G equals the expected growth rate. The cost of retained earnings is 11 .25% [($2.50 ÷ $40) + 0.05]. The formula for calculating the cost of new equity is ke = [(D1 + (Po --floating cost)]+ G. The cost of new equity is 11 .58%{[$2.50 + ($40 --$2)] + 0 .05}.Given the firm's target capital structure and its retained earnings balance of $900,000, the firm can raise $1 500,000 with debt and retained earnings before it must use outside equity. Therefore, the WACC for $0 -- $1 500,000 of financing is equal to 9.15% [04 (0.10)(1 --04) + 0.6(0.1125) = 0.0915]. Above $1,500,000, the firm must issue some new equity, so the WACC is 9.35% [04(0.10)(1 --04) + 0.6(0.1158) = 0.0935]. Projects A, B, and C will definitely be undertaken because the IRR is greater than the WACC. Next, determine whether Project D will be profitable. Financing Projects A, B, and C, requires $1 200,000 in capital. Therefore, the $550,000 needed for Project D would involve financing $300,000 with debt and retained earnings and $250,000 with debt and equity. Thus, the WACC for Project D is 9.24% [($300,000 + $550,000) x 0.0935], which is less than Project D's IRR. Thus, Projects A, B, C, and D should be accepted, and the firm's capital budget is $1 750,000.
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