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A. Explain two purposes of WACC in capital budgeting. B. H&H Manufacturing Company is considering two major investments. Respective cash flows are as follows: Project A Project B Cost 1,000,000 1,000,00 Cash Flows ($) 500,000 Year Cash Flows ($) 1 100,000 200,000 500,000 3 600,000 100,000 50,000 4 700,000 800,000 50,000 Both projects will be financed using funds generated from: 8 million $1 ordinary shares with a market value of $2.00 per share and an estimated cost of 15% i. i. 3 million $1 preference shares with a market value of 70 cents and an estimated cost of 8% i. 10 million debenture stocks with a market value of $90 per 100 nominal value and an estimated cost of 7% You are required to calculate the Net Present Value for both projects. C. Which project should be accepted and which should be rejected? D. Upon closer inspection of the accepted project, the CF0 realizes the company actually has some flexibility in managing this project. Specifically, if the market goes down, the company can abandon the project, and liquidate its original capital investment for 75% of its original value. If, however, the market should go up, the company could expand operations, which would result in twice the original PU. To expand the company will have to make an additional capital expenditure of $800,000. The CFO wants to know if the company should now proceed with the project with the added flexibilities, and asks for your advice. Discuss both the option to abandon and the option to expand. E. The CFO has also asked for your advice on how to apply the option to delay for the rejected project.

A. Explain two purposes of WACC in capital budgeting. B. H&H Manufacturing Company is considering two major investments. Respective cash flows are as follows: Project A Project B Cost 1,000,000 1,000,00 Cash Flows ($) 500,000 Year Cash Flows ($) 1 100,000 200,000 500,000 3 600,000 100,000 50,000 4 700,000 800,000 50,000 Both projects will be financed using funds generated from: 8 million $1 ordinary shares with a market value of $2.00 per share and an estimated cost of 15% i. i. 3 million $1 preference shares with a market value of 70 cents and an estimated cost of 8% i. 10 million debenture stocks with a market value of $90 per 100 nominal value and an estimated cost of 7% You are required to calculate the Net Present Value for both projects. C. Which project should be accepted and which should be rejected? D. Upon closer inspection of the accepted project, the CF0 realizes the company actually has some flexibility in managing this project. Specifically, if the market goes down, the company can abandon the project, and liquidate its original capital investment for 75% of its original value. If, however, the market should go up, the company could expand operations, which would result in twice the original PU. To expand the company will have to make an additional capital expenditure of $800,000. The CFO wants to know if the company should now proceed with the project with the added flexibilities, and asks for your advice. Discuss both the option to abandon and the option to expand. E. The CFO has also asked for your advice on how to apply the option to delay for the rejected project.

Managerial Accounting
Managerial Accounting
15th Edition
ISBN:9781337912020
Author:Carl Warren, Ph.d. Cma William B. Tayler
Publisher:Carl Warren, Ph.d. Cma William B. Tayler
Chapter12: Capital Investment Analysis
Section: Chapter Questions
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A. Explain two purposes of WACC in capital budgeting. B. H&H Manufacturing Company is considering two major investments. Respective cash flows are as follows: Project A 1,000,000 Cash Flows ($) Project B 1,000,00 Cash Flows ($) Cost Чеar 1 100,000 500,000 2 200,000 600,000 700,000 500,000 3 100,000 50,000 50,000 4 5 800,000 Both projects will be financed using funds generated from: i. 8 million $1 ordinary shares with a market value of $2.00 per share and an estimated cost of 15% 3 million $1 preference shares with a market value of 70 cents and an estimated cost of 8% ü. üi. 10 million debenture stocks with a market value of $90 per 100 nominal value and an estimated cost of 7% You are required to calculate the Net Present Value for both projects. C. Which project should be accepted and which should be rejected? D. Upon closer inspection of the accepted project, the CFO realizes the company actually has some flexibility in managing this project. Specifically, if the market goes down, the company can abandon the project, and liquidate its original capital investment for 75% of its original value. If, however, the market should go up, the company could expand operations, which would result in twice the original PU. To expand the company will have to make an additional capital expenditure of $800,000. The CFO wants to know if the company should now proceed with the project with the added flexibilities, and asks for your advice. Discuss both the option to abandon and the option to expand. E. The CFO has also asked for your advice on how to apply the option to delay for the rejected project.
Transcribed Image Text:A. Explain two purposes of WACC in capital budgeting. B. H&H Manufacturing Company is considering two major investments. Respective cash flows are as follows: Project A 1,000,000 Cash Flows ($) Project B 1,000,00 Cash Flows ($) Cost Чеar 1 100,000 500,000 2 200,000 600,000 700,000 500,000 3 100,000 50,000 50,000 4 5 800,000 Both projects will be financed using funds generated from: i. 8 million $1 ordinary shares with a market value of $2.00 per share and an estimated cost of 15% 3 million $1 preference shares with a market value of 70 cents and an estimated cost of 8% ü. üi. 10 million debenture stocks with a market value of $90 per 100 nominal value and an estimated cost of 7% You are required to calculate the Net Present Value for both projects. C. Which project should be accepted and which should be rejected? D. Upon closer inspection of the accepted project, the CFO realizes the company actually has some flexibility in managing this project. Specifically, if the market goes down, the company can abandon the project, and liquidate its original capital investment for 75% of its original value. If, however, the market should go up, the company could expand operations, which would result in twice the original PU. To expand the company will have to make an additional capital expenditure of $800,000. The CFO wants to know if the company should now proceed with the project with the added flexibilities, and asks for your advice. Discuss both the option to abandon and the option to expand. E. The CFO has also asked for your advice on how to apply the option to delay for the rejected project.
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