Homework Set # 4
Use the following information for Questions 1 through 3:
Assume you are presented with the following mutually exclusive investments whose expected net cash
flows are as follows:
EXPECTED NET CASH FLOWS:
Year Project A Project B
0 −$400 −$650
1 −528 210
2 −219 210
3 −150 210
4 1,100 210
5 820 210
6 990 210
7 −325 210
1. (a) What is each project’s IRR?
(b) If each project’s cost of capital were 10%, which project, if either, should be selected? If the
cost of capital were 17%, what would be the proper choice?
2. (a) What is each project’s MIRR at the cost of capital of 10%? At 17%? (Hint: Consider Period 7
as the end of Project B’s life.)
3. What is the crossover rate, and what is its significance?
Use the following information for Question 4:
The staff of Porter Manufacturing has estimated the following 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-risk 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 40,000
5* 0 20,000 30,000
4. 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.)
Homework Set #5
Use the following information for Questions 1 and 2:
Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013
Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are
expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This onetime
unusual earnings growth won’t be maintained, though, and after 2014 Boehm will return to its
previous 8% earnings growth rate. Its target debt ratio is 35%.
Calculate Boehm’s total dividends for 2014 under each of the following policies:
1. (a) Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in
(b) It continues the 2013 dividend payout ratio.
2. (a) It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3
million investment is financed with debt).
(b) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the
long-run growth rate and the extra dividend being set according to the residual policy.
Use the following information for Questions 3 and 4:
Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm’s fixed
costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the
firm’s assets (all equity financed) are $5 million. The firm estimates that it can change its production
process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1)
reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on
all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss
carry forwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt.
3. What is the incremental profit? To get a rough idea of the project’s profitability, what is the
project’s expected rate of return for the next year (defined as the incremental profit divided by the
investment)? Should the firm make the investment? Why or why not?
4. Would the firm’s break-even point increase or decrease if it made the change?