Deck 13: The Capital Budgeting Process

Question 1

TDJ Corp. needs $6.4 million in capital for its new state- of- the- art manufacturing facility. The current financing plan is 45% equity capital and 55% debt financing. Compute the WACC based on the following scenario if the company's effective income tax rate is 37.5%.
Debt Financing: 47% of the amount will be obtained through a bank loan at 10.6% per year and the remaining amount will be obtained through an issue of corporate bonds at a bond rate of 11.7% per year.
Equity Financing: 25% of the amount will be obtained through the issue of common stock that pays a dividend of 4.8% per year and 36% of the amount will be obtained through the issue of preferred stock that pays a dividend of 11.2% per year. The remaining amount will be taken from retained earnings that earn a rate of 7.5% per year.

Answer 1

7.51%

Question 2

A manufacturing company wants to acquire a new closed circuit TV CCTV) system. The new CCTV system can be purchased or it can be leased from the building in which the company has recently moved. If purchased, the system will cost $87,500 and will have a useful life of 5 years with no market value at that time. The annual operating cost is expected to be $52,000 per year. To lease the system, the company must pay a nonrefundable deposit of $21,500, an end- of- year leasing fee of $20,000, and an additional annual inspection and maintenance cost of $1000. Additionally, the operating costs incurred by the company will be reduced to $3400 per year. The company's after tax MARR is 10% per year and the effective income tax rate is 36% per year. Determine whether the company should purchase or lease the CCTV system. Assume straight- line depreciation with zero salvage value and a study period of 5 years.

Answer 2

AWPurchase10%) = - $50,062.50 AWLease10%) = - $21,287.70
Recommend leasing the system.

Question 3

George wants to evaluate the following investment options. He has collected the information below from the latest performance report for the VGT mutual fund. Use CAPM to approximate the expected return in each of the mutual fund categories. Assume that the risk- free investment is based on a 60- day U.S. Treasury Bill with a return of 3.85% per year.

Answer 3

Fund A: RS = 15.03%
Fund B: RS = 17.25% Fund C: RS = 23.62%

Question 4

DD&T, Inc. is considering the development of three new environmentally friendly products. One product will be selected from each of the high- end products and the commercial products lines. The company will set aside $2.5 million for this development. If the company's MARR is 8% per year, and all products have the same useful life of 7 years with zero salvage value, formulate the capital allocation problem as a linear programming model.

Question 5

GGV Corp. is considering the expansion of its networking and communication equipment production. Four projects are being considered. Projects A and B are mutually exclusive, and Projects C and D are mutually exclusive. Project C cannot be selected unless Project A or B has been selected. Project D is an optional add- on of Project A. The company's board of directors has approved $2 million for this expansion. In addition, because of limited personnel, only 27,000 labor hours can be committed to the expansion. Formulate the resource allocation problem as a linear programming model. Use a MARR of 7.2% per year.