The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $\$6,750$ and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability distributions:

$$\begin{matrix} \text{Project A} & \text{ } & \text{Project B}\\ \text{Probability} & \text{Cash Flows} & \text{Probability} & \text{Cash Flows}\\ \text{0.2} & \text{\$ 6000} & \text{0.2} & \text{\$ 0}\\ \text{0.6} & \text{6750} & \text{0.6} & \text{6750}\\ \text{0.2} & \text{7500} & \text{0.2} & \text{18000}\\ \end{matrix}$$

BPC has decided to evaluate the riskier project at $12\%$ and the less-risky project at $10\%$.

a. What is each project’s expected annual cash flow? Project B’s standard deviation $\left(\sigma_{\mathrm{B}}\right)$ is $\$5,798$, and its coefficient of variation $\left(\mathrm{CV}_{\mathrm{B}}\right)$ is 0.76. What are the values of $\sigma_{\mathrm{A}}$ and $\mathrm{CV}_{\mathrm{A}} ?$

b. Based on the risk-adjusted NPVs, which project should BPC choose?

St. Johns River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $24,000 to$46,000 per year. The new machine will cost $80,000; and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax rate is 40%, and the firm’s WACC is 10%. The old machine has been fully depreciated and has no salvage value. Should the old riveting machine be replaced by the new one? Explain your answer.

Your firm, Agrico Products, is considering a tractor that would have a cost of $36,000, would increase pretax operating cash flows before taking account of depreciation by$12,000 per year, and would be depreciated on a straight-line basis to zero over 5 years at the rate of $7,200 per year beginning the first year. (Thus, annual cash flows would be$12,000 before taxes plus the tax savings that result from $7,200 of depreciation.) The managers disagree about whether the tractor would last 5 years. The controller insists that she knows of tractors that have lasted only 4 years. The treasurer agrees with the controller, but he argues that most tractors do give 5 years of service. The service manager then states that some last for as long as 8 years. Given this discussion, the CFO asks you to prepare a scenario analysis to determine the importance of the tractor’s life on the NPV. Use a 40% marginal federal-plus-state tax rate, a zero salvage value, and a 10% WACC. Assuming each of the indicated lives has the same probability of occurring probability =1/3), what is the tractor's expected NPV?

The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for$2,500 at this time. Thus, the annual depreciation expense is $2,100 6=$350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life. Dauten is offered a replacement machine which has a cost of$8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The replacement machine would permit an output expansion, so sales would rise by$1,000 per year; even so, the new machine’s much greater efficiency would cause operating expenses to decline by $1,500 per year. The new machine would require that inventories be increased by$2,000, but accounts payable would simultaneously increase by $500. Dauten’s marginal federal-plus-state tax rate is 40%, and its WACC is 11%. Should it replace the old machine?

Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be “average.” However, the CFO realizes that conditions could be better or worse, so she performed a scenario analysis and obtained these results:$

$$\begin{matrix} \text{Economic Scenario} & \text{Probability of Outcome} & \text{NPV}\\ \text{Recession} & \text{0.05} & \text{(\$ 70 million)}\\ \text{Below average} & \text{0.20} & \text{(25 million)}\\ \text{Average} & \text{0.50} & \text{12 million}\\ \text{Above average} & \text{0.20} & \text{20 million}\\ \text{Boom} & \text{0.05} & \text{30 million}\\ \end{matrix}$$

$ Calculate the project’s expected NPV, standard deviation, and coefficient of variation.

Suppose you held a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio’s beta is 1.25. Now suppose you decided to sell one of the stocks in your portfolio with a beta of 1.0 for$7,500 and use the proceeds to buy another stock with a beta of 0.80. What would your portfolio’s new beta be?

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:

$$\begin{aligned} &\text { Project A }\\ &\begin{array}{cc} \hline \text { Probability } & \text { Net Cash Flows } \\ \hline 0.2 & \$ 6,000 \\ 0.6 & 6,750 \\ 0.2 & 7,500 \end{array} \end{aligned}$$

$$\begin{aligned} &\text { Project B }\\ &\begin{array}{cc} \hline \text { Probability } & \text { Net Cash Flows } \\ \hline 0.2 & \$ \quad 0 \\ 0.6 & 6,750 \\ 0.2 & 18,000 \end{array} \end{aligned}$$

BPC has decided to evaluate the riskier project at a 12% rate and the less risky project at a 10% rate.

a. What is the expected value of the annual net cash flows from each project? What is the coefficient of variation (CV)? (Hint: $\sigma_B$ = $5,798 and CV$_B$ = 0.76.)

b. What is the risk-adjusted NPV of each project?

Suppose that a firm must choose between two mutually exclusive projects, both of which have negative NPVs. Explain how a firm can legitimately choose between two such projects.

Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires 800,000 dollars of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The company's WACC is 8 percent, and its tax rate is 35 percent.

a. What would the depreciation expense be each year under each method?

b. Which depreciation method would produce the higher NPV, and how much higher would it be?

Colsen Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:

$$\begin{matrix} \text{Sales revenues} & \text{\$ 15 million}\\ \text{Operating costs (exluding depreciation)} & \text{10.5 million}\\ \text{Depreciation} & \text{3 million}\\ \text{Interest expense} & \text{3 million}\\ \end{matrix}$$

The company has a 40% tax rate, and its WACC is 11%. a. What is the project’s cash flow for the first year (t=1)? b. If this project would cannibalize other projects by $1.5 million of cash flow before taxes per year, how would this change your answer to part a? c. Ignore part b. If the tax rate dropped to 30%, how would that change your answer to part a?

A company has an 11% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following cash flows:

$$\begin{matrix} \text{ } & \text{0} & \text{1} & \text{2} & \text{3} & \text{4} & \text{5} & \text{6} & \text{7}\\ \text{Project A} & \text{- \$ 300} & \text{- \$ 387} & \text{- \$ 193} & \text{-\$ 100} & \text{\$ 600} & \text{\$ 600} & \text{\$ 850} & \text{- \$ 180}\\ \text{Project B} & \text{- \$ 405} & \text{\$ 134} & \text{\$ 134} & \text{\$ 134} & \text{\$ 134} & \text{\$ 134} & \text{\$ 134} & \text{\$ 0}\\ \end{matrix}$$

a. What is each project’s NPV? b. What is each project’s IRR? c. What is each project’s MIRR? d. From your answers to parts a, b, and c, which project would be selected? If the WACC was 18%, which project would be selected? e. Construct NPV profiles for Projects A and B. f. Calculate the crossover rate where the two projects’ NPVs are equal. g. What is each project’s MIRR at a WACC of 18%?

How radioactive isotopes decay?

You must evaluate a proposal to buy a new milling machine. The base price is 135,000 dollars and shipping and installation costs would add another 8,000 dollars. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for 94,500 dollars. The applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The machine would require a 5,000 dollars increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by 52,000 dollars per year. The marginal tax rate is 35 percent, and the WACC is 8 percent. Also, the firm spent 4,500 dollars last year investigating the feasibility of using the machine.

a. How should the 4,500 dollars spent last year be handled?

b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow?

c. What are the project’s annual cash flows during Years 1, 2, and 3?

d. Should the machine be purchased? Explain your answer.

Classify the following as a chemical or physical change: an egg breaks, a newspaper burns in the fireplace, a dish of ice cream is left out and melts, and a loaf of bread is baked.