1) Sandals Inc. is considering the purchase of a leather
cutting machine that will allow it to expand its product lines. It
will cost $14,000 and will be depreciated under the three-year
(MACRS) schedule (0.33, 0.45, 0.15, 0.07). It is estimated to have
a salvage value of $2,500 in 4 years. If this machine is purchased,
revenues are expected to increase by $8,000 in costs are expected
to increase by $5,000. In addition there will be a $6,000 increase
in work-in-process inventory. The firm's tax rate is 31% and the
required return for this project is 12%.
a) What is the initial outlay for this
project?
b) What is the incremental after-tax cash flow for
year?
c) What is the terminal year cash flow?
2) Ad Nauseum Inc. Has a target Capital structure of 40%
debt and 60% Equity. Up to $10,000 of new debt can be issued at 12%
no, but any new debt will cost the firm 14%. Retained earnings for
the current year are $50,000. Next year's expected dividend is
$4.00, dividends are growing at 8%, and the current stock price is
$20.00. If Ad Nauseum issues new common stock, the flotation costs
will be 10% of the issue price. The firm's tax rate is
31%.
a) What is the break point for debt
financing?
B) What is the cost of new equity?