Name _______________________ 1. The Pioneer Company is evaluating the replacement of one of its machines. The machine was originally purchased ten years ago at a cost of $45,000 and has been depreciated to a book value of zero. If Pioneer replaces the machine, it will be able to bid on larger projects that require the capabilities of the new machine. The new machine will cost the firm $50,000, which will be fully depreciated to a book value of 0 over 5 years according to the following MACRS-type depreciation rates: 30% in each of years 1 and 2, and 15% in each of years 3 and 4, and 10% in year 5. The new machine qualifies for an immediate 3% investment tax credit. Pioneer anticipates that at the end of the machine’s eight year economic life it will be sold for $10,000. Pioneer estimates that its existing machine can be sold today for $6,000. If Pioneer does not replace the machine, it anticipates being able to use the existing machine for eight more years at which time its salvage value would be zero. Without the purchase of the new machine, Pioneer expects to generate revenue of $200,000 per year. The firm’s use of its existing machine is expected to generate operating expenses of $120,000 per year. If the new machine is purchased, Pioneer expects the firm’s annual revenues and operating costs to increase to $260,000 and $160,000 respectively. Pioneer’s marginal tax rate is 25%. To finance this project, Pioneer will raise 30% of the capital from debt and 70% of the capital from equity; its after-tax cost of debt is 8% and the cost of equity is 18%, which results in a cost of capital of 15%. (18) a. Calculate the NPV for this project. (2) b. Calculate the IRR to 2 decimals; for example, 25.63%. (6) 2. Because of many reinvestment opportunities, the XYZ Company is not expected to pay any dividends for the next 4 years. Beginning 5 years from today, investors expect to receive a dividend of $2 per share for 3 years and then a dividend of $3 per share for each of the next 4 years. Then dividends are expected to grow at 2% per year forever. If investors require a 15% return, what is the price per share? (6) 3. The current price of DUMBA’s common stock is $30 per share. You plan on buying it today, holding it for 4 years, and then selling it. You anticipate receiving a dividend per share of $1.00 one year from today, $2.00 two years from today, $2.50 three years from today, and $2.50 four years from today. If you want to earn 20% on your investment, what price must you receive when you sell the stock four years from today? (8) 4. The Pioneer Corporation currently paid a $3.00 per share dividend on its common stock. Dividends are expected to grow forever at 3%, and investors require a 12% rate of return. Pioneer’s management is planning to enter new, risky markets to increase its expected dividend growth. However, in response to the increased risk, the investors’ required rate of return will increase to 15%. What must be the new value for the dividend growth to justify entering the new, risky markets and to keep the stock price from decreasing? 5. A $1,000 maturity value bond currently has 15 years left to maturity. The bond has an 8.5% coupon rate and pays interest annually. (5) a. If you want to earn a 7% rate of return, how much would you be willing to pay today for this bond? (5) b. Suppose you buy the bond for the value you calculated in part a. After holding the bond for 2 years and receiving 2 interest payments, you sell the bond for $1,032.43. What annual, compound rate of return have you earned over this 2 year period? (5) c. Suppose you buy the bond for the value you calculated in part a. After holding the bond for 2 years and receiving 2 interest payments, you sell the bond. What price must you receive (at time 2) to earn your desired 7% rate of return? (5) d. Suppose you buy the bond for the value you calculated in part a. After holding the bond for 3 years and receiving 3 interest payments, the bond defaults with no chance of paying you anything more. What annual, compound rate of return have you earned over this 3 year period?