UNIVERSITY OF TECHNOLOGY, JAMAICA
FINAL EXAMINATION GROUPS: MBA – Finance Major MONTEGO BAY DATE: October 9, 2010 DURATION: 2 HOURS
SUBJECT: Capital Budgeting
COURSE C0DE: MBA5016
INSTRUCTIONS: 1. This paper contains FIVE (5) questions. Attempt any FOUR (4) 2. This paper accounts for 30% of your final grade. 3. Begin the response to each question on a new page. 4. Silent electronic calculators may be used for this paper. 5. Financial tables are provided.
Question 1 AJA Manufacturers is considering replacing a machine used in its furniture manufactures business.. The machine currently in use has a net book value of $1 million, and would continue to be depreciated on a ...view middle of the document...
The land has known reserves of 60,000 barrels. The company wishes to know the market value of this operation. The interest rate is 8 percent and the marginal cost of pumping is $8 per barrel. Both of these costs are expected to remain unchanged over the three-year period. The current price of oil is $10 per barrel. ODR’s economists have estimated the following: Oil will increase in price by 10 percent with a probability of 40 percent, or decrease in price by 12 percent with a probability of 60 percent during each of the next three years. The cost of storing oil in above-ground tanks is $.50 per year. The company can pump a maximum of 20,000 barrels per year at the site. The site may be shut down for a year and then reopened at a cost of $2,000. Determine the market value of the operation ignoring taxes. Assume that all cash flows occur at the end of each year. (15 marks)
Question 3 Last year Nicole’s, Inc. had $90 million in total assets. Management desires to increase its plant and equipment during the coming year by $21 million. The company plans to finance 35% of the expansion with debt and the remaining 65% with equity capital. Bond financing will be at a 18% rate and will be sold at its par value. Common stock is currently selling for $54 per share, and flotation costs for new common stock will amount to $6 per share. The expected dividend next year for Nicole’s Inc is $3.00. Furthermore, dividends are expected to grow at a 7% rate far into the future. The marginal corporate tax rate is 30%. a) Calculate the weighted marginal cost of capital (to 2d.p.). (5 marks)
b) What impact will each of the following events have on a firm’s weighted average cost of capital? i. The corporate tax rate is lowered. The firm increases its leverage. ii. iii. The firm’s stock price falls dramatically. The Government imposes a stamp duty on the floatation of share. iv. The firm sells a division and replaces it with a less risky project. (10 marks) v.
Question 4 Andrea’s Garage decided to acquire a new Computerized Diagnostic Center for its Montego Bay Service center. The Diagnostic Center is estimated to cost $9,000,000 and an additional $1,000,000 for installation and training of staff. The present value of the tax write-off over the estimated 10 year life of the Diagnostic Center is $1,071,000. Customers are charged $10,000 each time they use the Diagnostic Center. Annual fixed costs is estimated at $900,000, variable transportation cost at $5,000 per use, marginal tax rate at 30 percent and the discount rate at 25 percent. I0 − D F + Q= PVIFAr , n ( P − V )(1 − t ) P − V a) What is minimum number of annual uses required to break-even? Assume that all cash outflows occur at the end of the year. (6 marks) b) Three types of risks are often associated with capital investment projects; (1) Total project risk, (2) firm risk and (3) systematic risk. Explain each and discuss their impact on capital budgeting analysis. (9 marks)