Answer $3,998.40 $4,609.18 $4,897.20 $5,281.55 $5,557.12 2) Safeco Company and R

Question

Answer            

                            
           $3,998.40                             
           $4,609.18                             
           $4,897.20                             
           $5,281.55                             
           $5,557.12






2)
Safeco Company and Risco Inc are identical in size and capital structure.  However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a WACC of 12%.  Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project.  Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project. Now assume that the two companies merge and form a new company, Safeco/Risco Inc.  Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y.  Which of the following statements is CORRECT? Answer                                         
           If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will probably become riskier over time.                             
           If evaluated using the correct post-merger WACC, Project X would have a negative NPV.                             
           After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.                             
           Safeco/Risco

Explanation / Answer

NPV when sales is 82000 units

Sales= 82000*43.29=3549780
less:variable cost= 82000*22.18=1818760
Less: fixed cost= 623000
Less: depreciation=336000

income before tax= 772020
LESS: tax @ 34%=(262486.8)
Income after tax=509533.2
Add: depreciation= 336000
Cash flow= 845533.2

NPV=-1.68+845533.2/1.10+845533.2/1.10^2....+845533.2/1.10^5=1525236.0677

NPV when sales is 82100 units

Sales = 82100*43.29=3554109
Less: variable cost=82100*22.18=1820978
Less:F.C.= 623000
Less: Dep. = 336000
Income before tax=774131
Less: Tax=263204.54
Income after tax= 510926.46
Add:dep. = 336000
Income after tax= 846926.46

NPV=-1.68+846926.46/1.10+846926.46/1.10^2....+846926.46/1.10^5=1530517.6192

So,sensitivity of NPV to a 100 unit cahnge in sale=1530517.6192-1525236.0677=$5,281.55

So, option D...i.e., 5281.55 ..is answer..

2. After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
As,coraporate WACC will be =(10+12)/2= 11%, which is more than project X IRR i.e., 10.5 % ,so, Option C is correct..

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