# Week 5 – Problems Set 2:FIN 571

1.    Bluegrass Distilleries, Inc. refuses to extend credit to any wholesale distributors who have a history of being delinquent in repaying credit extended to them.  This policy results in lost sales of \$10 million annually. Based on past experience with these types of customers, the firm estimates that the average collection period would be 90 days and that the bad-debt loss ratio would be 6 percent.  The firm’s variable cost ratio is 0.80, making its profit contribution ratio 0.20.  Bluegrass Distilleries’ required pretax return (i. e. opportunity cost) on receivables investments is 20 percent.  When converting from annual to daily or vice versa, assume there are 365 days per year.  If Bluegrass Distilleries extends credit to these (previously delinquent) customers, determine the increase in the investment in receivables.

2.    In Step Video is considering expanding its video rental library to 8,000 tapes.  The purchase price of the additional videos will be \$80,000 and the shipping cost is another \$4,000.  To house the tapes, the owner will have to spend another \$10,000 for display shelves, increase net working capital by \$5,000, and interest expenses will add another \$8,000 to the operating cost.  What is the net investment to In Step Video for this project?

3.    Baker Company is considering an investment in a new metal lathe.  If the new lathe is purchased, revenues will increase by \$5,000 per year and cash operating costs will decline by \$10,000 per year.  The lathe will cost \$60,000 and will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value.  Baker’s marginal tax rate is 40%.  Determine the annual net cash flows generated by the lathe.

4.     An investment project requires a net investment of \$100,000.  The project is expected to generate annual net cash inflows of \$28,000 for the next 5 years.  The firm’s cost of capital is 12 percent.  Determine the payback period for the project.

5.    An investment project requires a net investment of \$100,000.  The project is expected to generate annual net cash inflows of \$28,000 for the next 5 years.  The firm’s cost of capital is 12 percent.  Determine the net present value for the project.

6.    An investment project requires a net investment of \$100,000.  The project is expected to generate annual net cash inflows of \$28,000 for the next 5 years.  The firm’s cost of capital is 12 percent.  Determine the internal rate of return for the project.

7.    Quorex is evaluating two mutually exclusive projects.  Project A has a net investment of \$48,000 and net cash flows over a six year period of \$12,500 per year.  Project B also has a net investment of \$48,000 but its net cash flows of \$8,640 per year will occur over a 12 year period.  If Quorex has a cost of capital of 14% for these projects, which project, if either, should be chosen and what is its NPV?

8.    Determine the (after-tax) percentage cost of a \$50 million debt issue that the Mattingly Corporation is planning to place privately with a large insurance company.  Assume that the company has a 40% marginal tax rate.  This long-term debt issue will yield 12% to the insurance company.

9.    Determine the weighted cost of capital for the Mills Company that will finance its optimal capital budget with \$120 million of long-term debt (rd = 12.5%) and \$180 million in equity (re = 16.0%).  Mills’ present capital structure is considered optimal.  The company’s marginal tax rate is 40%.  (Compute answer to nearest .1%).

10.Bay State Technology has determined that its cost of equity is 15% and its after-tax cost of debt is 7.2%.  Bay State expects to earn \$14 million after taxes next year and, as a new firm, does not pay dividends.  The stock sells for \$24.  Bonds are currently selling at par value.  Compute Bay State’s weighted average cost of capital (WACC).  A partial balance sheet is shown below:

Current liabilities                              \$   300,000

Long-term debt                                   1,000,000

Common Stock at \$1 par                     100,000

Paid-in capital                                        900,000

Retained earnings                             3,000,000

Total liabilities and stock-

holder’s equity                             \$5,300,000

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