## We are evaluating a project that costs \$1,350,000, has a

We are evaluating a project that costs \$1,350,000, has a six-year life, and has no . Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 87,000 units per year. Price per unit is \$34.25, variable cost per unit is \$20.50, and fixed costs are \$750,000 per year. The tax rate is 35 percent, and we require an 11 percent return on this project.
a. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales.
b. What is the sensitivity of OCF to changes in the variable cost figure? Explain what your answer tells you about a \$1 decrease in estimated variable costs.

## In the previous problem, suppose your required return on the

In the previous problem, suppose your required return on the project is 10 percent and your pretax cost savings are \$190,000 per year. Will you accept the project? What if the pretax cost savings are only \$130,000 per year?

Data From Problem 14

Your firm is contemplating the purchase of a new \$520,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth \$40,000 at the end of that time. You will save \$160,000 before taxes per year in order processing costs, and you will be able to reduce working capital by \$35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project.

## A major college textbook publisher has an existing finance textbook.

A major college textbook publisher has an existing finance textbook. The publisher is debating whether or not to produce an “essentialized” version, meaning a shorter (and lower-priced) book. What are some of the considerations that should come into play? To answer the next three questions, refer to the following example. In 2003, Porsche unveiled its new sports-utility vehicle (SUV), the Cayenne. With a price tag of over \$40,000, the Cayenne goes from zero to 62 mph in 9.7 seconds. Porsche’s decision to enter the SUV market was in response to the runaway success of other high-priced SUVs such as the Mercedes-Benz M-class. Vehicles in this class had generated years of very high profits. The Cayenne certainly spiced up the market, and Porsche subsequently introduced the Cayenne Turbo S, which goes from zero to 60 mph in 4.8 seconds and has a top speed of 168 mph. The price tag for the Cayenne Turbo S? Over \$120,000 in 2009.
Some analysts questioned Porsche’s entry into the luxury SUV market. The analysts were concerned not only that Porsche was a late entry into the market, but also that the introduction of the Cayenne would damage Porsche’s reputation as a maker of high-performance automobiles.

## In 2007, baseball player Alex Rodriguez signed a contract reported

In 2007, baseball player Alex Rodriguez signed a contract reported to be worth \$275 million. The contract called for \$2 million immediately and \$27 million in 2008. The remaining \$246 million was to be paid as \$33 million in 2009, \$33 million in 2010, \$32 million in 2011, \$30 million in 2012, \$32 million in 2013, \$25 million in 2014, \$21 million in 2015, and \$20 million in 2016 and 2017. If the appropriate interest rate is 11 percent, what kind of deal did the infielder snag? Assume all payments other than the first \$2 million are paid at the end of the year.

## Why is underpricing not a great concern with bond offerings?Use

Why is underpricing not a great concern with bond offerings?
Use the following information to answer the next three questions. Eyetech Pharmaceuticals, Inc., a company that develops treatments for eye problems, went public in January 2004. Assisted by the investment bank Merrill Lynch, Eyetech sold 6.5 million shares at \$21 each, thereby raising a total of \$136.5 million. At the end of the first day of trading, the stock sold for \$32.40 per share, down slightly from a high of \$33.00. Based on the end-of-day numbers, Eyetech shares were apparently underpriced by about \$11 each, meaning that the company missed out on an additional \$74 million.

## Photochronograph Corporation (PC) manufactures time series photographic equipment. It is

Photochronograph (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .6. It’s considering building a new \$65 million manufacturing facility. This new plant is expected to generate aftertax cash flows of \$7.75 million in perpetuity. The company raises all equity from outside financing. There are three financing options:
1. A new issue of common stock: The required return on the company’s new equity is 15 percent.
2. A new issue of 20-year bonds: If the company issues these new bonds at an annual rate of 7 percent, they will sell at par.
3. Increased use of financing: Because this financing is part of the company’s ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio of to long-term debt of .15.
(Assume there is no difference between the pretax and aftertax cost.)

## Organic Produce Corporation has 7.5 million shares of common stock

Organic Produce has 7.5 million shares of outstanding, 500,000 shares of 7 percent preferred stock outstanding, and 175,000 of 8.2 percent semiannual bonds outstanding, \$1,000 each. The currently sells for \$64 per share and has a beta of 1.2, the preferred stock currently sells for \$108 per share, and the bonds have 15 years to and sell for 96 percent of par. The market risk premium is 6.8 percent, T-bills are yielding 5.5 percent, and the firm’s tax rate is 34 percent.

a. What is the firm’s market value capital structure?
b. If the firm is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

## Regions, Inc., has 6 million shares of common stock outstanding.

Regions, Inc., has 6 million shares of outstanding. The current share price is \$61, and the book value per share is \$4. Regions also has two bond issues outstanding. The first bond issue has a of \$70 million, a 7 percent coupon, and sells for 98 percent of par. The second issue has a of \$35 million, a 6.5 percent coupon, and sells for 97 percent of par. The first issue matures in 20 years, the second in 12 years.
a. What are the company’s weights on a book value basis?
b. What are the company’s weights on a market value basis?
c. Which are more relevant, the book or market value weights? Why?

## For the firm in Problem 7, suppose the book value

For the firm in Problem 7, suppose the book value of the debt issue is \$90 million. In addition, the company has a second debt issue, a zero bond with 10 years left to maturity; the book value of this issue is \$60 million, and it sells for 52.5 percent of par. What is the total book value of debt? The total market value? What is the aftertax now?

Data from Problem 7

Peyton’s Colt Farm issued a 30-year, 7 percent semiannual bond 7 years ago. The bond currently sells for 94 percent of its face value. The company’s tax rate is 35 percent.

## Website. Webmasters.com has developed a powerful new server that would

Website. Webmasters.com has developed a powerful new server that would be used for corporations’ Internet activities. It would cost \$10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 10% of the year’s projected sales; for example, NWC0 5 10%(Sales1). The servers would sell for \$24,000 per unit, and Webmasters believes that variable costs would amount to \$18,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company’s nonvariable costs would be \$1 million at Year 1 and would increase with inflation.

The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project’s returns are expected to be highly correlated with returns on the firm’s other assets. The firm believes it could sell 1,000 units per year.

The equipment would be depreciated over a 5-year period, using MACRS rates.

The estimated market value of the equipment at the end of the project’s 4-year life is \$500,000. Webmasters.com’s federal-plus-state tax rate is 25%. Its is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with an 8% project and high-risk projects at 13%.

a. Develop a spreadsheet model, and use it to find the project’s NPV, IRR, and payback.

b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables’ values at 10% and 20% above and below their base-case values. Include a graph in your analysis.

c. Now conduct a scenario analysis. Assume that there is a 25% probability that bestcase conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions.

d. If the project appears to be more or less risky than an average project, find its riskadjusted NPV, IRR, and payback.

e. On the basis of information in the problem, would you recommend the project should be accepted?