MGT302 Homework 7

Homework
7—MGT302

1.
You
are saving for retirement and you come across the following table. It shows the
percentage of your current salary that you should save for your retirement in
order to maintain the same level of consumption spending both before and after
retirement. It assumes that your annual salary will remain constant in real
terms until retirement, and that you will live for 25 years after retiring. For
instance, if you have 35 years left before you retire and earn 3.5% per year on
your investment, then you should save 19.82% of your current salary. Fill in
the missing numbers in the table A.

Table
A Saving to maintain lifetime consumption spending

Real interest rate

Years to retirement

15

25

35

3.5% per annum

?

?

19.82%

4.5% per annum

?

?

?

2.
You
are taken a product management position within a major consumer goods firm
after graduation. The contract is for four years and your compensation package
is as follows:

·
$5000
relocation expense

·
$55,000
annual salary

·
$10,000
bonus if annual goals are met

·
$15,000
additional bonus at the end of four years if your team achieves a given market

share

You
are confident in your abilities and assume there is a 65% chance in receiving
each annual bonus and a 75% chance in receiving the fourth year additional
bonus. The effective annual interest rate is 8.5%. What is the net present
value of your compensation package?

3.
Your
firm is considering two investment projects with the following pattern of
expected future net after-tax cash flows. The appropriate cost of capital for
both projects is 10%.

Year

0

1

2

3

4

5

Project A

-$10

$1

$2

$3

$4

$5

Project B

-$10

$5

$4

$3

$2

$1

a.
Which
project is better?

b.
Find
the internal rate of return (real rate of return) of two projects and decide
which one is better.

c.
Use
Excel to draw the graph of net present value and interest rate which is shown
in lecture slides. The only difference is that there are two curves in the
graph.

4.
Hu’s
Software Design, Inc is considering the purchase of a computer that has an
economic life of

4
years and it is expected to have no salvage value. It will cost $80,000 and it
will be depreciated using the straight-line depreciation method. It will save
the company $35,000 the first year and it is assumed that the saving after that
will have a growth rate of 5%. It will also reduce net working capital
requirements by $7000. The corporate tax rate is 35% and the appropriate
discount rate is 14%. What is the value that the purchase will add to the firm?

5.
Steiness
Danish Ham, Inc. is contemplating buying a new machine that has an economic
life of 5 years. The cost of the machine is 1,242,000 krone and will be fully
depreciated using the straight-line depreciation method over 5 years. At the
end of 5 years, it will have a market value of 138,000 krone. It is estimated
that the new machine will save the company 345,000 krone per year due to
reduced labor costs. Moreover, it will lead to a reduction in net working
capital of 172,500 krone because of the higher yield from raw materials
inventory. The net working capital will be recovered by the end of 5 years. If
the corporate tax rate is 34% and the discount rate is 12%, what is the NPV of
the project?

6.
Healthy
Hopes Hospital Supply Corporation is considering an investment of $500,000 in a
new plant for producing disposable diapers. The plant has an expected life of 4
years. Sales are expected to be 600,000 units per year at a price of $2 per
unit. Fixed costs excluding depreciation of the plant are $200,000 per year and
variable costs are $1.2 per unit. The plant will be depreciated over 4 years
using the straight-line method with a zero salvage value. The discount rate for
the project is 15% per year and the corporation pays income tax at the rate of
34%. Find

a.
The
level of sales that would give a zero accounting profit.

b.
The
level of sales that would give a 15% after-tax accounting rate of return on the
$500,000 investment.

c.
The
IRR, NPV and payback period (Both conventional and discounted) if expected
sales are 600,000 units per year.

d.
The
level of sales that would give an NPV of zero.