BUS test

BUS

5

3

0 Test Number 3 March

1

0,

2

021

Student name: ________________________________________________

1) Attempt all the questions on the test.

2)
Show all work
. That is show the steps involved in getting the answer. This will enable me to provide partial credit. It is possible to get up to 90% on a question if the answer is wrong and the steps are correct. If you do not show the steps, then the answer is either correct or wrong and partial credit.

Useful Formulae

 

 

 

 

11.52%

 

 

 

8.93%

 

 

MACRS recovery allowance per year
Class of Investment
Ownership year	3-year	5-year	7 -year
1	33.33%	20.00%	1 4 .29%
2	44.45%	32.00%	24.49%
3	14. 8 1%	19.20%	17.49%
4	7.41%		11.52%	12.49%
5		8.93%
6	5.76%	8.92%
7
8	4.46%

Use the following information for Questions 1 and 2

Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The equipment for the project is classified as 3-year life using the MACRS depreciation, after which it would be worth nothing and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s 4-year life.

WACC	10.0%
Initial investment	$165,000
	Sales revenues, each year	$123,000
	Business expenses		$25,000
	Tax rate	35%

Question 1. (Show all work for credit)

Calculate the depreciation amount for each year of the life of the equipment.

Question 2. (Show all work for credit)

Calculate the project’s NPV.

Use the following information for Questions 3 and 4

Great Subs Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, which is currently financed using 20% debt at a cost of 8% and 80% equity. Great Subs’ analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $6 million in Year 3, and $8 million in Year 4. The acquisition would be made immediately, if it is to be undertaken. Eastern’s required return on equity is 18%. The tax rate is 40% and the long-termgrowth rate of the cash flows after year 4 is 4%.

Question 3. (Show all work for credit)

What is Eastern’s horizon value?

Question 4. (Show all work for credit)

What is Eastern pizza value?

Use the following information for Questions 5 and 6

Dakota Trucking Company (DTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC’s tax rate is 40%.

Question 5. (Show all work for credit)

What is the cost of borrowing and buying the truck?

Question 6. (Show all work for credit)

Calculate the cost of leasing the truck.

Should the firm lease or buy?

Question 7. (Show all work for credit)

Your company, CSUS Inc., is considering a new project whose data are shown below. The required equipment has a 3-year MACRS tax class. Revenues and other operating costs are expected to be constant over the project’s 4-year expected operating life. The salvage value of the equipment is $0.

Sales revenues, each year

Business expenses

$25,000

Tax rate

Equipment cost	$70,000
$42,500
35.0%

What is the project’s Year 4 cash flow?

Question 8. (Show all work for credit)

Why do different buyers have different values when calculating the value of target company in a merger and acquisition?

Question 9. (Show all work for credit)

Why do we use the cost of equity without debt when calculating the value of merger and acquisition target instead of the cost of capital (WACC)?

Question 10. (Show all work for credit)

What is the minimum lease payment from the point of view of the owner (Lessor) that would make purchasing a computer system and writing a 6-year lease contract on it feasible? The price of the computer system is $175,000, it is a five-year asset for depreciation purposes, it has a residual value of $3,000, the cost of capital (WACC) is 9%, and the corporate tax rate is 40%.