Exam2 Key

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

2. Net Present Value – Secondly, Peter needs to investigate the Net Present Value (NPV) of each project scenario, i.e. job type, gross margin, and # new diamonds drills purchased. The NPV will measure the variance of the present value of cash outflow (drilling equipment investment) versus the future value of cash inflows (future profits), at the benchmark hurdle rate of 20%. A positive NPV associated with the investment means that the investment should be undertaken as it exceeds the minimum rate of return. A higher NPV determines which project scenario will have the highest return on cash flow, hence determining the most profitable investment in terms of present money value.

b) The decision to invest in projects increases the shareholders value of the company. This is consistent with the growth and from the NPV criteria, positive NPV of projects increases the shareholder's value.

9. What is the Cost of Debt, before and after taxes? Using the interest rate for the largest debt…cannot use the weighted interest rate for the debt since it includes capital lease obligations with no stated rate and could not find in the notes to the financials. 5.4% After tax cost is .054 x (1-.36) = 3.5%

The 8 percent pre-tax estimate is the nominal cost of debt. Because the firm's debt has semiannual coupons, its effective annual cost rate is 8.16 percent

- The Bet-r-Bilt Company has a 5-year bond outstanding with a 4.30 percent coupon. Interest payments are paid semi-annually. The face amount of the bond is $1,000. This bond is currently selling for 93 percent of its face value. What is the company's pre-tax cost of debt?

The tax rate is estimated from case Exhibit 2 as Income Taxes ($496 million) divided by Earnings Before Taxes, Non-controlling Interest and Goodwill Amortization ($990 million). Note that, in 2001, interest on the company’s total debt is approximately 3.8%: $317 million of interest / $8,361 million of debt. However, this calculation is misleading since the 2000 debt is much larger than the 1999 debt of $2,270 (not in the case). You should ask yourself…should you use current yields or historical yields when calculating the cost of debt? Current yield figures should be used because Telus is considering

Barring further analysis, the positive NPV indicates HPL should accept the proposal and proceed with expansion, as it would add value to the company. However, it should be noted that the NPV only becomes positive in year 10 (it is negative in all previous years). Thus, if HPL fails to extend the initial three-year contract with its largest retail customer and the project does not endure the estimated 10-year lifespan, it could in fact produce a loss in value for the company.

Calculate the after tax cost of debt using the following information (hint: see page 285 in text).

Account for time. Time is money. We prefer to receive cash sooner rather than later. Use net present value as a technique to summarize the quantitative attractiveness of the project. Quite simply, NPV can be interpreted as the amount by which the market

Net Present Value (NPV) calculates the sum of discounted future cash flows and subtracting that amount with the initial investment of the project. If the NPV of a project results in a positive number, the project should be undertaken. It is the most widely used method of capital budgeting. While discount rate used in NPV is typically the organization’s WACC, higher risk projects would not be factored in into the calculation. In this case, higher discount rate should be used. An example of this is when the project to be undertaken happens to be an international project where the country risk is high. Therefore, NPV is usually used to determine if a project will add value to the company. Another disadvantage of NPV method is that it is fairly complex compared to the other methods discussed earlier.

Weights of Debt and equity are 8.3 and 91.7%. Now, plugging all the values in, we can derive company’s Weighted Average Cost of Capital.

In the case of Worldwide Paper Company we performed calculations to decide whether they should accept a new project or not. We calculated their net income and their cash flows for this project (See Table 1.6 and 1.5). We computed WPC’s weighted average cost of capital as 9.87%. We then used the cash flows to calculate the company’s NPV. We first calculated the NPV by using the 15% discount rate; by using that number we calculated a negative NPV of $2,162,760. We determined that the discount rate of 15% was out dated and insufficient. To calculate a more accurate NPV for the project, we decided to use the rate of 9.87% that we computed. Using this number we got the NPV of $577,069. With the NPV of $577,069 our conclusion is to accept this

4. Based on the information provided in the case, our group calculated the NPV for the project under both tax environment and tax-free condition, respectively, by using the excel spreadsheet and the NPV function. (For a detailed calculation of NPV, please refer to Appendix Under 15-yr.) According to our calculation, we have the following results: In the first case scenario, which the firm is in a tax environment (35% income tax), the NPV of the project equals to -$6,366,054.53

This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.