1. Xavier Publishing is thinking of purchasing a new printing and binding machin
ID: 2752257 • Letter: 1
Question
1.
Xavier Publishing is thinking of purchasing a new printing and binding machine. The machine will cost $120,000, plus $7,500 to ship and install the equipment. The new machine will have a 5-year useful life and will be depreciated on a straight-line basis. The machine is expected to generate sales of $25,000 per year and is expected to save $17,000 per year in labor and electrical expenses over the next 5 years. The machine is expected to have a salvage value of $30,000. Xavier uses a 13.5% discount rate for capital budgeting purposes and the firm's income tax rate is 40%. What is the machine's NPV?
02.
The market risk premium is 12% and the risk free rate of return is 3%. Kent Construction's marginal tax rate is 40% and its beta is 1.8. Analysts expect Kent's dividends to grow by 5% per year for the foreseeable future. Using the capital asset pricing model, what is Kent's cost of retained earnings?
Explanation / Answer
1)
Given intitial investment = $ 1,20,000+$7,500
= $ 127,500
Cash outflow = $ 127,500
Calculation of cash inflows;
Given savings = $ 17,000
less: Tax @ 40% = $ 6,800
Profit after tax = $10,200
Add : Depreciation.
( 1,27,500-30,000)/5 = $19,500
Cash inflows = $29.700
Calculation of NPV: ( IN $)
DISCOUNTED CASH INFLOWS
PRESENT VALUE
OF CASH INFLOWS
Since NPV is negative it is not good of purchasing machine
2)
In capital asset pricing model Ke = Rf+(Rm-Rf)*B
= 0.03+(0.12-0.03)1.8
= 19.2
Retained Earnings Kr=ke(1-T)
= 19.2(1-04)
= 11.52
YEAR CASH INFLOWS DISCOUNT FACTORDISCOUNTED CASH INFLOWS
1 29,700 0.8810 26,165 2 29,700 0.7762 23,053 3 29,700 0.6839 20,311 4 29,700 0.6025 17,894 5 29,700 0.5309 15,767PRESENT VALUE
OF CASH INFLOWS
103,190 LESS : CASH OUTFLOW 1,27,500 NPV (24,310)Related Questions
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