Chapter 18 International Capital Budgeting

Chapter 18 International Capital Budgeting 1.  Before you pose these next seven questions to your students, give consideration consideration to their  finance backgrounds. At my school (University (University of Missouri at olumbia! capital budgeting questions in this level of detail "ould be #fair game# because the students have had plenty of capital budgeting before in a prior finance course. $ust glancing at equations %&'% through %&'f  is not preparation for these seven questions. )here are plenty of easier questions in this test bank. Tiger Towers, Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to bu. The land cost !1,""",""" and the pament is due toda. Construction of a #"$unit office building will cost  pretax !% million& this expense will be depreciated straight$line straight$line over %" ears to 'ero salvage value& the value of the land and building in ear %" will be !18,""",""". The !%,""",""" construction cost is to be paid toda. The project will not change the ris( level of the firm. The firm will lease #" offices suites at !#",""" per suite per ear& pament is due at the start of the ear& occupanc will begin in one ear. )a )ariable cost is !%,*"" !%,*" " per suite. +ixed costs, excluding depreciation, are !*,""" per ear. The project will re-uire a !1",""" investment in net wor(ing capital.

#. hat is the unlevered after$tax incremental cash flow for ear "/ 0. $!%,",""" 0.  $!%,",""" B. $!*,1"",""" B.  $!*,1"",""" C. $!2,""",""" C.  $!2,""",""" D. $!2,"1",""" 3. 4one 3.  4one of the above $!2,"1",""" 5 $ 6!1,""",""" 7 !%,""",""" 7 1",""" %. hat is the unlevered after$tax incremental cash flow for ear #/ 0. $!2,1" 0.  $!2,1" B. !1"#,%"" B.  !1"#,%"" C. !#"#,%"" 9. !#**,""" 9.  !#**,""" 3. 4one 3.  4one of the above

2. hat is the unlevered after$tax incremental cash flow for ear %"/ 0. !1#,2%#,%"" B. !1#,##*,%:" C. !1#,%%#,%"" 9. !1#,28*,""" 3. 4one of the above !1#,2%#,%"" 5 !#"#,%"" 7 return of 4C 7 building;land #"#,%"" 7 !1",""" 7 !18,""",""" $ ".%2 × s answer to -uestion 2? Correct response to @* 5 response to @2 7 !1",""" 7 !18,""",""" $ ".%2 × t hard. Import their responses into 3xcel. se if statements. The advantage of path$dependent grading is that ou can get the same level of discrimination in grading on a multiple choice test as on an essa test. *. +or the next % -uestions, assume that the firm will partiall finance the project with a !%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments. hat is the levered after$tax incremental cash flow for ear "/ A. $!1,"1",""" B. $!1,""",""" C. $!",""" 9. $!#,1"",""" 3. 4one of the above  *+ " 5 !%,""",""" $ response to @% = $!1,"1",""" Aou ma wish to award partial credit on this -uestion according to the following rubric $!1,"1",""" is correct if @%5 2= $!1,""",""" is correct if @% 5 %= $!",""" is correct if @% 5 1= $!#,1"",""" is correct if @% 5 #=

. +or the next % -uestions, assume that the firm will partiall finance the project with a !%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments. hat is the levered after$tax incremental cash flow for ear 1/ A. !2,%"" B. $!#"#,1" C. $!:*,"" 9. !*,""" 3. 4one of the above Aour response to @2 $ !%"",""" × ".

 4ote? ou ma wish to award partial credit according to? !2,%"" is correct if @2 5 %= $!#"#,1" is correct if @2 5 1= $!:*,"" is correct if @2 5 #= !*,""" is correct if @2 5 2= . +or the next % -uestions, assume that the firm will partiall finance the project with a !%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments. hat is the levered after$tax incremental cash flow for ear %"/ 0. !:,"#,%:" B. !:,#%2,%"" C. !:,1%2,%"" 9. !:,#8,""" 3. 4one of the above

the right answer is our response to @* $ !%"",""" × ". $ !%,""","""

Aou should consider awarding partial credit on this according to this rubric? !:,"#,%:" is correct if @* 5 #= !:,#%2,%"" is correct if @* 5 1= !:,1%2,%"" is correct if @* 5 %= !:,#8,""" is correct if @* 5 2= 8. 0ssume that the firm will partiall finance the project with a subsidi'ed !%,""",""" interest onl %"$ear loan at 8." percent 0DE with annual paments. 4ote that eight percent is less than the 1" percent that the normall borrow at. hat is the 4D) of the loan/ 0. !1:8,2: B. !*%,::.8% C. !1"#,#.** D. !1,%%2,8*1.": 3. 4one of the above sing the cash flow menu on a financial calculator? C+" 5 !%,""",""" C+1 5 $!1*8,2"" 5 $!%,""",""" × "."8 × . +"1 5 #: C+# 5 $!%,1*8,2"" I 5 1"F  4D) 5 !1,%%2,8*1.":

:. The firm>s tax rate is %2F. The firm>s pre$tax cost of debt is 8F& the firm>s debt$to$e-uit ratio is %& the ris($free rate is %F& the beta of the firm>s common stoc( is 1.*& the mar(et ris( premium is :F. hat is the firm>s cost of e-uit capital/ 0. %%.%%F B. 1".8*F C. 1%.1#F D. 1.*F 3. 4one of the above r e-uit  5 %F 7 1.* × :F 5 1.*F

1". The firm>s tax rate is %2F. The firm>s pre$tax cost of debt is 8F& the firm>s debt$to$e-uit ratio is %& the ris($free rate is %F& the beta of the firm>s common stoc( is 1.*& the mar(et ris(  premium is :F. hat is the re-uired return on assets/ 0. %%.%%F B. 1".8*F C. 1%.1#F 9. 1.*F 3. 4one of the above 1.*F 5 r asset 7 % × 6 r asset  $ r debt × s income. The ield to maturit on our firm>s existing debt is 8F. hat is the 0D) of this subsidi'ed loan/  4ote that I did not round m intermediate steps. If ou did, our answer ma be off b a bit. Jelect the answer closest to ours. 0. $!%,2:,##2.2% B. !21,#"1."* C. !82",: 9. 4one of the above

+irst, get our financial calculator into begin mode and 1 pament per ear? D) 5 1",""","""  45 % I5 *F DGT 5 $!%,2:,##2.2% 0morti'e the loan

The si'e and timing of the cash flows of the loan are?

C+" 5 !,*"#,*.* C+1 5 $!%,%8,.#2 C+# 5 $!%,22","#." I5 8F& 4D) 5 !21,#"1."* If ou are covering 0D) in detail, this (ind of -uestion is appropriate. 0lternative versions of this are nearb.

18. Toda is Hanuar 1, #"":. The state of Iowa has offered our firm a subsidi'ed loan. It will be in the amount of !1",""",""" at an interest rate of *F and have 0440 t round m intermediate steps. If ou do, ou>re not going to get the right answer. A. $!1,2",%"1.#* B. !1#,2:2,2%.* C. !%,*8",.** 9. !1"8,::2.18.#" 3. !*:,2*:,%"1."% )he "eighted average cost of capital is r e-uit 5 1"F 7 % ×