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Homework answers / question archive / Economics Homework 8 IEEN 5329 Homework 8 10
Economics Homework 8
IEEN 5329
Homework 8
10.4, 10.13, 10.14, 10.21
PROBLEMS
When two or more alternatives are com-pared using the PW, AW, or BIC method, them are three circumstances for which the length of time of the evaluation period is the same for all alternatives. List these three circumstances.
10.2 For what evaluation methods is it mandatory that an incremental cash [low series analysis be performed to ensure that the correct alternative is selected?
10.3 Explain what is meant by the decision guideline to choose the "numerically largest value" when selecting the one best. Mutually exclusive alternative from two or more alternatives.
10.4 For the following situation. (a) Determine which evaluation Method is probably the easiest and fastest to apply by hand and by computer in order to select from the five alternatives, and (b) answer the two questions, using your chosen evaluation method.
An independent dirt contractor must determine which size dump truck to buy. The cash flows estimated with each size truck bed are tabulated. The MARR is 18% per year and all alternatives are expected—to have a useful life of 8 years. (1) What site truck bed should be purchased? (b) 11 two trucks are to be purchased, what should be the size of the second truck?
|
Truck Bed Size, Cubic Meters |
Initial Investment, $ |
AOC $/year |
Salvage Value, $ |
Annual Revenue, $/year |
|
8 |
-10,000 |
-4,000 |
2,000 |
6,500 |
|
10 |
-14,000 |
-5,500 |
2,500 |
+10,000 |
|
15 |
-18,000 |
-7,000 |
+3,000 |
+14,000 |
|
20 |
-24,000 |
-11000 |
+3,500 |
+20,500 |
|
25 |
-33,000 |
-16,000 |
+6,000 |
+26,500 |
10.5 Read Problem 9.26. (a) Determine which evaluation method is probably the easiest and faste.st to apply by hand and by computer in order to select from the two alternatives. 0) If the evaluation method you chose is different from that used in Chapter 9, solve the problem using, your chosen evaluation method.
10.6 For what type of alternatives should the capitalized cost method be used for comparison? Give several examples of these types of projects.
Working with MARR
10.7 Alter 15 years of employment in the air-line industry, John started his own consulting company to use physical and computer simulation in the analysis of commercial airport accidents on run-ways. He estimates his average cost of new capital at 8% per year for physical simulation projects, that is, where he physically reconstructs the accident using scale versions of planes, buildings, vehicles, etc. He has established 12% per year as his MARR.
(a) What (net) rate of return on capital investments for physical simulation does he expect?
(b) John was recently offered an inter-national project Unit that he considers risky in that the information avail-able is sketchy and the airport personnel do not appear to be willing to cooperate on the investigation. John considers this risk to be economically worth at least an added 5% return Of his money. What is the recommended MARR in this situation based upon what you have learned in this chapter? How should john consider the required return and perceived risk factors when evaluating this project opportunity?
10.8 State whether each of the following involves debt financing or equity financing. (a) A bond issue for $3,500,000 by a city-owned utility
(b) An initial public offering (IPO) of $35,000,000 in common stock fora dot-com company
(c) $25,000 Taken from your retirement account to pay cash for a new car
(d) A homeowner's equity loan for $25,000
10:9 Explain how the opportunity cost sets the effective MARR when because of limited capital only one alternative can be selected from two or more.
10.10 The board of directors of the Brazilia Group has less capital than needed to fund a $6.2 million project in the Middle East. Had it been funded an estimated i* of 18% per year would result. Corporate MARR = 15% has been applied for before-tax analysis. With the available $2.0 million in equity capital, a project with an estimated i*of 16.6% is approved. The group president just asked you to estimate the after-tax opportunity cost that has been forgone. Assume you collect the following information in preparation to answer him: Effective federal tax rate = 20% per year Effective state tax rate = 6% per year Equation for overall effective tax rate = state rate+ (1 - state rate)(federal rate) hint: First develop a drawing similar to Figure 1-6 for the Brazilia Group situation.)
10,11 The initial investment and incremental ROR values for four mutually exclusive alternative are indicated below. Selected the best alternative if a maximum of (a) $300,000 (b) $400,000 and (c) $700,000 in capital funds is available and the MARR is the cost of capital. Which is estimated at 9% per year, (d) what is the de facto MARR is stated the available capital is $400,000 and the opportunity cost interpretation is applied?
|
Alternative |
Initial Investment, $ |
Incremental Rate of Return, % |
Alternative rate of Return , % |
|
1 |
-100,000 |
8.8 for 1 to DN |
8.8 |
|
2 |
-250,000 |
12.5 for 2 to DN |
12.5 |
|
3 |
-400,000 |
11.3 for 3 to 2 |
14.0 |
|
4 |
-550,000 |
8.1 for 4 to 3 |
10.0 |
10.12 State the recommended approach in establishing the MARR when other factors. such as alternative risk, taxes, and market fluctuations are considered in addition to the cost of capital.
10.13 A partnership of four engineers operates a duplex rental business. Five years ago they purchased a block of duplexes, using a MARR of 14% per year. The estimated return at that time fax the duplexes was 15%. per year. But the investment was considered very risky due to the poor rental business economy in the city and state overall. Nonetheless, the purchase was made with 100% equity financing at a cost of 10% per year. Fortunately, the return has averaged 18% per year over the 5 years. Another purchase opportunity for more duplexes hits now presented itself, but a loan at 8% per year would has e to be taken to make the investment. (a) If the economy for rental property has nest changed significantly. is there likely to be a tendency to now make the MARR higher than, lower than, or the same as that used previously'? Why? (b) What is the recommended way to consider the rental business economy risk now that debt capital would be involved?
D_E Mix and WACC
10.14 A new cross-country, trans mountain range water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating companies has not fully decided the financial arrangements of this adventurous project. The WACC for similar projects has aver-aged 10% per year. (a) Two financing alternatives have been identified. The first requires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second alternative requires only 20% equity funds and the balance obtained by a massive international loan estimated to carry an interest cost of 12.5% per year. Which is in part, based on the geographic location of the pipeline. Which financing, plan will result in the smaller average cost of capital?
(b) If the consortium CFOs have decided that the WACC must not exceed the 5-year historical average of 10% per year. What is the maximum loan interest acceptable for each financing alternative?
10.15 A couple is planning ahead for their child's college education. They can fund part or all of the expected $100.000 tuition cost from their own funds (through an Education IRA) or borrow all or part of it. The expected return for their own funds is 8% per year but the loan is expected to have higher interest rates as the amount of the loan increases. Use a spreadsheet-generated plot of the WACC curve and the estimated loan interest rates below to determine the best D-E mix for the couple.
|
Loan Amount, $ |
Estimated Interest Rate, % per year |
|
10,000 |
7.0 |
|
25,000 |
7.5 |
|
50,000 |
9.0 |
|
60,000 |
10.0 |
|
75,000 |
12.0 |
|
1000,000 |
18.0 |
10.16 Tiffany Baking Co. wants to arrange for $50 million in capital for manufacturing a new consumer product. The current financing plan is 60% equity capital and 40% debt financing. Compute the WACC for the following financing scenario.
Equity capital 60%, or $35 million, via common stock sales for 40% of this amount that will pay dividends at a rate, of 5% per year, and the remaining 60% from retained. earnings, which currently earn 9% per year. Debt capital: 40%, or $15 million, obtained through two sources--bank loans for $10 million borrowed at 8% per year, and the remainder in convertible bonds at an estimated 10% per year bond interest rate.
10.17 The possible D-E mixes and costs of debt and equity capital for a new project are summurized below. Use the data (a) to plot the curves for debt, equity, and weighted average costs of capital and (b} to determine what mix of debt and equity capital will result in the lowest. WACC.
|
|
Debt Capital |
Equity Capital |
||
|
Plan |
Percentage |
Rate, % |
Percentage |
Rate, % |
|
1 |
100 |
14.5 |
|
|
|
2 |
70 |
13.0 |
30 |
7.8 |
|
3 |
65 |
12.0 |
35 |
7.8 |
|
4 |
50 |
11.5 |
50 |
7.9 |
|
5 |
35 |
9.9 |
65 |
9.8 |
|
6 |
20 |
12.4 |
80 |
12.5 |
|
7 |
|
|
100 |
12.5 |
10.18 For Problem 10.17, use it spreadsheet to (a) determine the best D-E mix and (b) determine the best D-E mix if the cost of debt capital increases by 10% per year.
10.19 A public corporation in which you own common stock reported a WACC of 10.7% for the year in its annual report to stockholders. The common stock that you own has averaged a total return or 6% per year over the last 3 years. The annual report also mentions that projects within the corporation are 80% funded by its own capital. Estimate the company's cost of debt capital. Does this seem like a reasonable rate for borrowed funds?
10.20 To understand the advantage of debt capital from a tax perspective in the United States. Determine the before-tux and after-tax weighted average costs of capital if a project is funded 40%-60% with debt capital harrowed at 9% per year. A recent study indicates that corporate equity funds earn 12% per year and that the effective tax rate is 35% for the year.
Cost of Debt Capital
10.21 Bristol Myers Squibb, an international pharmaceutical company, is initiating a new project for which it requires $2.5 million in debt capital/The current plan is to sell 20-year bonds that pay 4.2% per year. Payable quarterly, at a 3% discount on the face value. BMS has an effective tax rate of 35% per year. Determine (a) the total face value of the bonds required to obtain $2.5 million and (b) the effective annual after-tax cost of debt capital.
10.22 The Sullivan’s plan to purchase a refurbished condo in. their parents' hometown for investment purposes. The negotiated $200,000 purchase price will he financed with 20% of their savings which consistently make 6.5% per year after all relevant income. Taxes are paid. Eighty percent will be borrowed at 9% per year for 15 years with the principal repaid in equal annual installments. If their effective tax rate is 22% per year, based only on these data, answer the following. (Note: The 9% rate on the loan is a before-tax rate.)
a) What is the Sullivan’s annual loan payment for each of the 15 years?
(b) What is the net-present worth difference between the $200,000 now and the PW of the cast of the 80-20 D-E mix series of cash flows necessary to finance the purchase?
What does this number mean?
(c) What is the Sullivans’ after-tax WACC for this purchase?
10.23 An engineer is working on a design project for a plastics manufacturing company that has an after-tax cost of equity capital of 6% per year for retained earnings that may be used to 100% equity finance the project. An alternative financing strategy is to issue %4 million worth of 10-year bonds that will pay 8% per year interest on a quarterly basis. If the effective tax rate is 40%, which funding source has the lower cost of capital?
10.24 Tri-States Gas Processors expects to borrow $800,000 for field engineering improvement. Two methods of debt financing are possible borrow it all from bank or issue debenture bonds. The company will pay an effective 8% compound per year for 8 years to the bank. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of each annual payment going toward interest. The bond issue will be 800 10-year bonds of S1000 each that require a 6% per year interest payment.
(a) Which method of financing is cheaper after an effective tax rate of 40% is considered?
(b) What is the cheaper method using a before-tax analysis?
10.25 Charity Hospital, established in 1895 as a nonprofit corporation, pays no taxes on income and receive no tax advantage for interest paid. The board of directors has approved expanded cancer treatment equipment that will require $10 million in debt capital to supplement $8 million in equity capital currently available. The $10 million can be borrowed at 7.5% per year through the Charity Hospital Corporation, Alternatively, 30-year trust bonds could be issued through the hospitals for-profit outpatient corporation, Charity Outreach, Inc. The interest on the bonds is expected to be 9.75% per year is tax-deductible. The bonds will be sold at a 2.5% discount for rapid sale. The effective tax rate of Charity Outreach is 32%, which form of debt financing is less expensive after taxes?
Cost of Equity Capital
10.26 Common stocks issued by Henry Harmon Builders paid stockholders $0.93 per share on an average price of S18.80 last year. The company expects to grow the dividend rate at a maximum of 1.5% per year. The stock volatility of 1.19 is somewhat higher than that of other public firms in the construction industry, and other stocks in this market are paying an average of 4.95% per year dividend. U.S. Treasury bills are returning 4.5% determine the company's cost of equity capital last year, using (a) the dividend method and (b) the CAPM.
10.37 Government regulations from the U.S. Department of Agriculture. (USDA) re-quire that a Fortune 500 corporation implement the .HACCP (Hazards Analysis and Critical. Control Points) loud safety program in its beef processing plants in 21 states. To finance the equipment and personnel training portions of this new program. Wholesome Chickens expects to use a D-E mix of 60%-40%: to finance a $10 million effort for improved equipment, engineering, and quality control. After-tax cost of debt, capital for loans is known to be 9.5% per year, However, obtaining sufficient equity capital will require the sale of common stock. as well as the commitment of corporate retained earnings. Use the following information to determine the WACC for the implementation of HACCP
Common stock: 100,000 shares
Anticipated price = $32 per share
Initial Dividend = $1.10 per share
Dividend Growth per share = 2% annually
Retained earnings: same cost of capital as for common stock
10.28 Last year a Japanese engineering materials corporation. Yamachi Inc. purchased same U.S. Treasury bonds that return an average of 4% per year. Now. Euro bonds are being purchased with a realized average return of 3.9% per year. The volatility factor of Yamachi stock last year was 1.10 and has increased this year to 1.18. Other publicly traded stocks in this same business are paying an average of 5.1% dividends per year. Determine the cost of equity capital for each year and explain why the increase or decrease seems to have occurred.
10.29 An engineering graduate plans to purchase a new car. He has not decided how in pay the purhase price of $28,000 for the SUV he has selected. He has the total available in a savings account, so paying cash is an option: however, this would deplete virtually all his savings. These funds return an average of 6% per year, compounded every 6 months. Perform a before-tax analysis to determine which or the three financing plans below has the lowest WACC.
Plan 1: D-E is 50%-50%
Use$14,000
from the savings account and borrow $14.000 at a rate of 7% per year. Compounded monthly. The difference between the payments and the savings would be deposited at 6% per year, compounded semi-annually.
Plan 2: 100% equity. Take $28,000 from savings now. Plan 3: 100% debt. Borrow $28,000 now from the credit union at an effective rate of 0.75% per month and repay the loan at $581.28 per month for 60 months.
10.30 OI Logistics.com has a total of 1.53 million shares of common stock outstanding at a market price of $28 per share. The before-tax coat of equity capital of common stock is 15% per year. Stocks fund 50% of the company's capital projects. The remaining capital is generated by equipment trust bonds and slum-term loans. Thirty percent of the debt capital is from $5,000,000 worth of $10,000 6% per year 15-year bonds. The remaining 70% of debt capital is from loans repaid at an effective 10.5% before taxes. If the effective income tax rate is 35%, determine the weighted average cost of capital (a) before taxes and (b) alter taxes.
10.31 Three projects have been identified. Capital will be developed 70% from debt sources at an average rate of 7.0% per year and 30% from equity sources at 10.34% per year. Set the MARR equal to WACC and make the economic decision, if the projects are (a) independent and (b) mutually exclusive. Annual Net Cash Initial Flow, Salvage life, Project Investment, S S/year Value, $ Years
|
Project |
Initial Investment, $ |
Flow, $/ Year |
Salvage Value, $ |
Life, Years |
|
1 |
-25,000 |
6,000 |
4,000 |
4 |
|
2 |
-30,000 |
9000 |
-1000 |
4 |
|
3 |
-50,000 |
15,000 |
20,000 |
4 |
10.32 Shadowland, a manufacture of air freight able pet crates, has identified two projects that, though having a relatively high risk are expected to move the company, into new revenue markets. Utilize a spreadsheet solution (a) to select any combination of the projects if MARR = after-tax WACC and (b) to determine if the same projects should be selected if the risk factors are enough to require an additional 2% per year for the investment to be made.
|
Project |
Initial Investment, $ |
Tax cash flow per year, $/year |
Life, Years |
|
Wildlife (W) |
-250,000 |
48,000 |
10 |
|
Reptiles ( R) |
-125,000 |
30,000 |
5 |
Financing will be developed using a D-E mix of 60-40 with equity funds costing 7.5% per year. Debt financing will be developed from $10,000 5% per year, paid quarterly, 10-year bonds. The effective tax rate is 30% per year.
10.33 The federal government imposes requirements upon industry in many areas, such as employee safety. Pollution control environment protection and noise control. One view of these regulations is that their compliance tends to decrease the return can investment and/or increase the cost of capital to the corporation. In many cases the economics of these regulated compliances cannot be evaluated as regular engineering economy alternatives. Use your knowledge of engineering economic analysis to explain how an engineer might canonically evaluate alternatives that define the ways in which the company will comply with imposed regulations.
Different D-E Mixes
10.34 Why is it financially unhealthy for an individual to maintain a large percentage of debt financing over a long period of time. That is, to be highly debt-leveraged?
10.35 Fairmont Industries primarily relies on 100% equity financing to Fund projects. A good opportunity is available that will require $250.000 in capital. The Fairmont owner can supply the money from personal investments that currently earn an average of 8.5% per year. The annual net cash flow from the project is estimated at $30,000 for the next 15 years. Alternatively, 60% of the required amount can be borrowed for 15 years at 9% per year. If the MARR is the WACC, determine which plan, if either, is better. This is a before tax analysis.
10.36 Mrs. McKay has different. methods by which a $600,000 project can be funded, using debt and equity capital. A net cash flow of $90,000 per year is estimated for 7 years.
|
Type of Financing |
Financing Plan % |
Cost per Year. % |
||
|
1 |
2 |
3 |
||
|
Debt |
20 |
50 |
60 |
10 |
|
Equity |
80 |
50 |
40 |
7.5 |
Determine the rate of return for each plan, and identify the ones that are economically acceptable if (a) MARR equals the cost of equity capital, (b) MARR equals the WACC, or MARR is halfway between the cost or equity capital and the WACC.
10.37 Mosaic Software has an opportunity to invest $10.000,000 in a new engineering remote-control system for offshore drilling platforms. Financing for mosaic will be split between common stock sales ($5,000,000) and a loan with an 8% per year interest rate, Mosaic share of the annual net cash flow is estimated to be $2.0 million for each of the next 6 years, Mosaic is about to initiate CAPM as its common stock evaluation model. Recent analysis shows that it has a volatility rating of 1.05 And is paying a premium of 5% common stock dividend. The U.S. Treasury bills are currently paying 4% per year. Is the venture financially attractive if the MARR equals (a) the cost of equity capital and (b) the WACC'?
10.38 Draw the general shape of the three cost of capital curves (debt, equity, and WACC). using the form of Figure 10-2. Draw them under the, condition that high D-E mix has been present for some time for the corporation. Explain via your graph and words the movement of the minimum WACC point under historically high leveraged D-E mixes. Hint: High D-E mixes cause the debt cost to increase substantially. This makes it harder to obtain equity funds, SO the cost of equity capital also increases.
10.39 In a leveraged buyout of one company by another, the purchasing company usually obtains borrowed money and insert as kittle of its own equity funds as possible into the purchase. Explain some circumstances under which such a buy-out may put the purchasing company at economic risk.
Multiple-Attribute Evaluation
10.40 A committee of four people submitted the following statements about the at-tributes to be used in a weighted attribute method. Use the statements to determine the normalized weights if scores are assigned between 0 and 10.
|
Attribute |
Comment |
|
1. Flexibility |
The most important factor |
|
2. Safety |
50% as important as uptime |
|
3. Uptime |
One-half as important as flexibility |
|
4. Speed |
As important as Uptime |
|
5. Rate of Return |
Twice as important as safety |
10.41 Different types and capacities or crawler hoes are being considered for use in major' excavation on a pipe-laying project. Several supervisors on similar projects of the past have identified some of the attributes and their views of the importance of an attribute. 'The information has been shared with you. Determine the weighted rank order, using a 0 to 100 scale and the normalized weights.
|
Attribute |
Comment |
|
Truck versus hoe loading beight |
Vitally important factor |
|
Type of lopsoil |
Usually only 10% of the problem |
|
Type of soil below topsoil |
One half as important as matching trenching and laying speeds |
|
Hoe cycle time |
About 75% as important as soil type below topsoil |
|
Match hoe trenching speed to pipe-laying speed |
As important as attribute number one |
10.42 You graduated 2 years ago, and you plan to purchase a new car. For three different models you have evaluated the initial cost and estimated annual costs for fuel and maintenance. You also evaluated the styling of each ear in your role as a young engineering professional. List some additional 'factors (tangible and in-tangible) that might be used in your version of the weighted attribute method.
10.43 (Note to instructor): This and the next two problems may be assigned as a progressive exercise John who works at Swatch has decided to use the weighted attribute method to compare three system for manufacturing a watchband. The vice president and her assistant bave evaluated each of three attributes in terms of importance to them, and john has placed an evaluation from 0 to 100 on each alternative for the three Attributes. John’s ratings are as follows:
|
Attribute |
1 |
2 |
3 |
|
Economics return > MARR |
50 |
70 |
100 |
|
High throughput |
100 |
60 |
30 |
|
Low Scrap rate |
100 |
40 |
50 |
Use the weights below to evaluate the alternatives. Are the results the same for the two persons' weights' Why?
|
Important Score |
VP |
Assistant VP |
|
Economics return > MARR |
20 |
100 |
|
High throughput |
80 |
60 |
|
Low Scrap rate |
100 |
20 |
10.44 In Problem 10.43 the vice president and assistant vice president are not consistent in their weights of the three attributes. Assume you are a consultant asked to assist John.
(a) What are some conclusions yon can draw about the weighted attribute method as an alternative selection method, given the alternative ratings and results in Problem 10,437•
(b) Use the new alternative rating below that you have developed yourself to select an alternative. Using the same scores as the vice president and her assistant given in Problem 10.43 comment on any difference in the alternative selected.
(c) What do your new alternative ratings tell you about the selections based on the importance scores of the vice president and assistant vice president?
|
Attribute |
1 |
2 |
3 |
|
Economics return > MARR |
30 |
40 |
100 |
|
High throughput |
70 |
100 |
70 |
|
Low Scrap rate |
100 |
80 |
90 |
10.45 The watchband division discussed in Problems 10.43 and 10.44 has just been lined $1 million for environmental pollution due to the poor quality of its dis-charge water. Also. John has become the vice president and there is no longer an assistant vice president. John always agreed with the importance scores of the Cornier assistant vice president and the alternative ratings he developed earlier (those present initially in Problem 10.43 If he adds his own importance. score of 80 to the new factor of environmental cleanliness and awards alternatives lives 1, 2, and 3 ratings of 80, 50. and 20. respectively for this new factor. redo the evaluation to select the best alternative.
10.46 For Example 10.10, use an equal weighting of 1 for each attribute to choose the alternative. Did the weighting of attributes change the selected alternative?
10.47 The Athlete's Shop has evaluated two proposals for weight lifting and exercise equipment. A present worth analysis at 15% of estimated incomes and costs resulted in PW, = $420.500 and PW8 = $392.800. In addition to this economic measure, three attributes were independently assigned a relative importance score from 0 to 100 by the shop manager and the lead trainer.
|
Attribute |
Manager |
Trainer |
|
Economics |
100 |
80 |
|
Durability |
35 |
10 |
|
Flexibility |
20 |
100 |
|
Maintainability |
20 |
10 |
Separately, you have used the four attributes to rate the two equipment proposals on a scale of 0.0 to 1.0. The economics attribute was rated using the PW values.
|
Attribute |
Proposal A |
Proposal B |
|
Economics |
1.00 |
0.90 |
|
Durability |
0.35 |
1.0 |
|
Flexibility |
1.00 |
0.90 |
|
Maintainability |
0.25 |
1.00 |
Select die better proposal, using each of the following methods.
(a) Present worth (b) Weighted evaluations of the manager (c) Weighted evaluations or the lead trainer
EXTENDED EXERCISE
EMPHASIZING THE RIGHT THINGS
A fundamental service provided to the citizens of a city is police protection. Increasing crime rates that include injury to persons have been documented in the close-in suburbs in Belleville. a densely populated historic area north of the capital. In phase I of the effort the police chief has made and preliminarily examined four proposals of ways in which police surveillance and protection may be pro-vided in the target residential areas, in brief, they are placing additional officers in cars- on bicycle on foot, or on horseback. Each alternative, has been evaluated separately to estimate annual costs. Placing six new officers on bicycles is clearly the least expensive Talon at an estimated $700,000 per year. The next best is on foot with 10 new officers at $925.000 per year. The other alternative% will cost ,slightly more than the "on foot" option.
Before entering phase It which is a 3-month pilot study to test one or two of these approaches in the neighborhoods. a committee of five members (comprised of police staff and citizen-residents) has been asked to help determine and prioritize attributes that are important in this decision to them, as representatives of the residents and police officers. The five attributes agreed upon after 2 months of discussion are listed below. Followed by each committee member's ordering of the attributes from the most important (a score of 1) to the least important La score 5).
|
Attribute |
1 |
2 |
3 |
4 |
5 |
Sum |
|
Ability to become ‘close’ to the citizenry |
4 |
5 |
3 |
4 |
5 |
21 |
|
Annual Cost |
3 |
4 |
1 |
2 |
4 |
14 |
|
Response time upon call or dispatch |
2 |
2 |
5 |
1 |
1 |
11 |
|
Number of Blocks in coverage area |
1 |
1 |
2 |
3 |
2 |
9 |
|
Safety of Officers |
5 |
3 |
4 |
5 |
3 |
20 |
Questions
1. Develop weights that can be used in the weighted attribute method for each attribute. The committee members have agreed that the simple average of their live ordered-attribute scores can be considered the indicator of how important each attribute is to them as a group.
2. One committee member recommended, and obtained committee approval for, reducing the attributes considered in the final selection to only those that were listed as number I by one or more committee members. Select these attributes and recalculate the weights as requested in question 1.
3. A crimes prevention analyst in the Police Department applied the weighted attribute method to the ordered attributes in question 1. The R1 values obtained using Equation DAM ate listed below. Which two options should the police chief select for the pilot study?
|
Alternative |
Car |
Bicycle |
Foot |
Horse |
|
R1 |
62.5 |
50.5 |
47.2 |
35.4 |
CASE STUDY
WHICH WAY TO GO DEBT OR EQUITY FINANCING?
The Opportunity
Pizza Hut Corporation bus decided to enter the catering business in three states within its Southeastern US. Division, using the name Pizza Hut At-Your-Place. To deliver the meals and serving personnel, it is about to purchase 200 vans with custom interiors for a total or $1.5 million. Each van is expected to be used for 10 years and have a $1000 salvage value.
A feasibility study completed last year indicated that the At-your-Place business veture could realize an estimated annual net cash flow of $300,000 before taxes in the three states. After-tax considerations would have to take into account the effective tax rate or 35% paid by Pizza Hut.
An engineer with Pizza Huts Distribution Division has worked with the corporate finance office to deter-mine how to best develop the $1.5 million capital needed for the purchase of vans. There are two viable financing plans
The Financing' Options
Plan A is debt financing for 50% or the capital ($750,000) with the 8% per year compound interest loan repaid over 10 year with uniform year-end payments. (A simplifying assumption that $75,000 of the principal is repaid with each annual payment can be made.)
Plan B is 100% equity capital raised from the sale of $15 per share common stock. The financial manager informed the engineer that stock is paying $0.50 per share in dividends and that this dividend rate has been increasing at an average of 5% each year. This dividend pattern is expected to continue, based on the current financial environment.
Case Study Exercises
1. What values of MARR should the engineer use to determine the better financing plan?
2. The engineer must make a recommendation on the financing plan by the end of the day. He does not know how to consider all the tax angles for the debt financing in plan A. However, he does have a handbook that gives these relations for equity and debt capital about taxes and cash flows:
Equity Capital: no income tax advantages
After-tax net cash flow (before tax. net cash flow)(1 Tax rate) Debt- capital: income tax advantage comes from interest paid on loans
After-tax net cash flow = before-tax net cash now - loan principal - Joan interest - taxes
Taxes= (taxable income) (tax rate)
Taxable income= net cash flow - loan interest
He decides to forget any other tax consequences and use this information to prepare a recommendation. Is A or B the better plan?
3. The division manager would like to know how much the WACC varies for different D-E mixes, especially about 15% to 20% on either side of the 50% debt financing option in plan A, Plot the WACC curve and compare its Shape with that of Figure 10-2.
PROBLEMS
When two or more alternatives are com-pared using the PW, AW, or BIC method, them are three circumstances for which the length of time of the evaluation period is the same for all alternatives. List these three circumstances.
10.2 For what evaluation methods is it mandatory that an incremental cash [low series analysis be performed to ensure that the correct alternative is selected?
10.3 Explain what is meant by the decision guideline to choose the "numerically largest value" when selecting the one best. Mutually exclusive alternative from two or more alternatives.
10.4 For the following situation. (a) Determine which evaluation Method is probably the easiest and fastest to apply by hand and by computer in order to select from the five alternatives, and (b) answer the two questions, using your chosen evaluation method.
An independent dirt contractor must determine which size dump truck to buy. The cash flows estimated with each size truck bed are tabulated. The MARR is 18% per year and all alternatives are expected—to have a useful life of 8 years. (1) What site truck bed should be purchased? (b) 11 two trucks are to be purchased, what should be the size of the second truck?
|
Truck Bed Size, Cubic Meters |
Initial Investment, $ |
AOC $/year |
Salvage Value, $ |
Annual Revenue, $/year |
|
8 |
-10,000 |
-4,000 |
2,000 |
6,500 |
|
10 |
-14,000 |
-5,500 |
2,500 |
+10,000 |
|
15 |
-18,000 |
-7,000 |
+3,000 |
+14,000 |
|
20 |
-24,000 |
-11000 |
+3,500 |
+20,500 |
|
25 |
-33,000 |
-16,000 |
+6,000 |
+26,500 |
10.5 Read Problem 9.26. (a) Determine which evaluation method is probably the easiest and faste.st to apply by hand and by computer in order to select from the two alternatives. 0) If the evaluation method you chose is different from that used in Chapter 9, solve the problem using, your chosen evaluation method.
10.6 For what type of alternatives should the capitalized cost method be used for comparison? Give several examples of these types of projects.
Working with MARR
10.7 Alter 15 years of employment in the air-line industry, John started his own consulting company to use physical and computer simulation in the analysis of commercial airport accidents on run-ways. He estimates his average cost of new capital at 8% per year for physical simulation projects, that is, where he physically reconstructs the accident using scale versions of planes, buildings, vehicles, etc. He has established 12% per year as his MARR.
(a) What (net) rate of return on capital investments for physical simulation does he expect?
(b) John was recently offered an inter-national project Unit that he considers risky in that the information avail-able is sketchy and the airport personnel do not appear to be willing to cooperate on the investigation. John considers this risk to be economically worth at least an added 5% return Of his money. What is the recommended MARR in this situation based upon what you have learned in this chapter? How should john consider the required return and perceived risk factors when evaluating this project opportunity?
10.8 State whether each of the following involves debt financing or equity financing. (a) A bond issue for $3,500,000 by a city-owned utility
(b) An initial public offering (IPO) of $35,000,000 in common stock fora dot-com company
(c) $25,000 Taken from your retirement account to pay cash for a new car
(d) A homeowner's equity loan for $25,000
10:9 Explain how the opportunity cost sets the effective MARR when because of limited capital only one alternative can be selected from two or more.
10.10 The board of directors of the Brazilia Group has less capital than needed to fund a $6.2 million project in the Middle East. Had it been funded an estimated i* of 18% per year would result. Corporate MARR = 15% has been applied for before-tax analysis. With the available $2.0 million in equity capital, a project with an estimated i*of 16.6% is approved. The group president just asked you to estimate the after-tax opportunity cost that has been forgone. Assume you collect the following information in preparation to answer him: Effective federal tax rate = 20% per year Effective state tax rate = 6% per year Equation for overall effective tax rate = state rate+ (1 - state rate)(federal rate) hint: First develop a drawing similar to Figure 1-6 for the Brazilia Group situation.)
10,11 The initial investment and incremental ROR values for four mutually exclusive alternative are indicated below. Selected the best alternative if a maximum of (a) $300,000 (b) $400,000 and (c) $700,000 in capital funds is available and the MARR is the cost of capital. Which is estimated at 9% per year, (d) what is the de facto MARR is stated the available capital is $400,000 and the opportunity cost interpretation is applied?
|
Alternative |
Initial Investment, $ |
Incremental Rate of Return, % |
Alternative rate of Return , % |
|
1 |
-100,000 |
8.8 for 1 to DN |
8.8 |
|
2 |
-250,000 |
12.5 for 2 to DN |
12.5 |
|
3 |
-400,000 |
11.3 for 3 to 2 |
14.0 |
|
4 |
-550,000 |
8.1 for 4 to 3 |
10.0 |
10.12 State the recommended approach in establishing the MARR when other factors. such as alternative risk, taxes, and market fluctuations are considered in addition to the cost of capital.
10.13 A partnership of four engineers operates a duplex rental business. Five years ago they purchased a block of duplexes, using a MARR of 14% per year. The estimated return at that time fax the duplexes was 15%. per year. But the investment was considered very risky due to the poor rental business economy in the city and state overall. Nonetheless, the purchase was made with 100% equity financing at a cost of 10% per year. Fortunately, the return has averaged 18% per year over the 5 years. Another purchase opportunity for more duplexes hits now presented itself, but a loan at 8% per year would has e to be taken to make the investment. (a) If the economy for rental property has nest changed significantly. is there likely to be a tendency to now make the MARR higher than, lower than, or the same as that used previously'? Why? (b) What is the recommended way to consider the rental business economy risk now that debt capital would be involved?
D_E Mix and WACC
10.14 A new cross-country, trans mountain range water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating companies has not fully decided the financial arrangements of this adventurous project. The WACC for similar projects has aver-aged 10% per year. (a) Two financing alternatives have been identified. The first requires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second alternative requires only 20% equity funds and the balance obtained by a massive international loan estimated to carry an interest cost of 12.5% per year. Which is in part, based on the geographic location of the pipeline. Which financing, plan will result in the smaller average cost of capital?
(b) If the consortium CFOs have decided that the WACC must not exceed the 5-year historical average of 10% per year. What is the maximum loan interest acceptable for each financing alternative?
10.15 A couple is planning ahead for their child's college education. They can fund part or all of the expected $100.000 tuition cost from their own funds (through an Education IRA) or borrow all or part of it. The expected return for their own funds is 8% per year but the loan is expected to have higher interest rates as the amount of the loan increases. Use a spreadsheet-generated plot of the WACC curve and the estimated loan interest rates below to determine the best D-E mix for the couple.
|
Loan Amount, $ |
Estimated Interest Rate, % per year |
|
10,000 |
7.0 |
|
25,000 |
7.5 |
|
50,000 |
9.0 |
|
60,000 |
10.0 |
|
75,000 |
12.0 |
|
1000,000 |
18.0 |
10.16 Tiffany Baking Co. wants to arrange for $50 million in capital for manufacturing a new consumer product. The current financing plan is 60% equity capital and 40% debt financing. Compute the WACC for the following financing scenario.
Equity capital 60%, or $35 million, via common stock sales for 40% of this amount that will pay dividends at a rate, of 5% per year, and the remaining 60% from retained. earnings, which currently earn 9% per year. Debt capital: 40%, or $15 million, obtained through two sources--bank loans for $10 million borrowed at 8% per year, and the remainder in convertible bonds at an estimated 10% per year bond interest rate.
10.17 The possible D-E mixes and costs of debt and equity capital for a new project are summurized below. Use the data (a) to plot the curves for debt, equity, and weighted average costs of capital and (b} to determine what mix of debt and equity capital will result in the lowest. WACC.
|
|
Debt Capital |
Equity Capital |
||
|
Plan |
Percentage |
Rate, % |
Percentage |
Rate, % |
|
1 |
100 |
14.5 |
|
|
|
2 |
70 |
13.0 |
30 |
7.8 |
|
3 |
65 |
12.0 |
35 |
7.8 |
|
4 |
50 |
11.5 |
50 |
7.9 |
|
5 |
35 |
9.9 |
65 |
9.8 |
|
6 |
20 |
12.4 |
80 |
12.5 |
|
7 |
|
|
100 |
12.5 |
10.18 For Problem 10.17, use it spreadsheet to (a) determine the best D-E mix and (b) determine the best D-E mix if the cost of debt capital increases by 10% per year.
10.19 A public corporation in which you own common stock reported a WACC of 10.7% for the year in its annual report to stockholders. The common stock that you own has averaged a total return or 6% per year over the last 3 years. The annual report also mentions that projects within the corporation are 80% funded by its own capital. Estimate the company's cost of debt capital. Does this seem like a reasonable rate for borrowed funds?
10.20 To understand the advantage of debt capital from a tax perspective in the United States. Determine the before-tux and after-tax weighted average costs of capital if a project is funded 40%-60% with debt capital harrowed at 9% per year. A recent study indicates that corporate equity funds earn 12% per year and that the effective tax rate is 35% for the year.
Cost of Debt Capital
10.21 Bristol Myers Squibb, an international pharmaceutical company, is initiating a new project for which it requires $2.5 million in debt capital/The current plan is to sell 20-year bonds that pay 4.2% per year. Payable quarterly, at a 3% discount on the face value. BMS has an effective tax rate of 35% per year. Determine (a) the total face value of the bonds required to obtain $2.5 million and (b) the effective annual after-tax cost of debt capital.
10.22 The Sullivan’s plan to purchase a refurbished condo in. their parents' hometown for investment purposes. The negotiated $200,000 purchase price will he financed with 20% of their savings which consistently make 6.5% per year after all relevant income. Taxes are paid. Eighty percent will be borrowed at 9% per year for 15 years with the principal repaid in equal annual installments. If their effective tax rate is 22% per year, based only on these data, answer the following. (Note: The 9% rate on the loan is a before-tax rate.)
a) What is the Sullivan’s annual loan payment for each of the 15 years?
(b) What is the net-present worth difference between the $200,000 now and the PW of the cast of the 80-20 D-E mix series of cash flows necessary to finance the purchase?
What does this number mean?
(c) What is the Sullivans’ after-tax WACC for this purchase?
10.23 An engineer is working on a design project for a plastics manufacturing company that has an after-tax cost of equity capital of 6% per year for retained earnings that may be used to 100% equity finance the project. An alternative financing strategy is to issue %4 million worth of 10-year bonds that will pay 8% per year interest on a quarterly basis. If the effective tax rate is 40%, which funding source has the lower cost of capital?
10.24 Tri-States Gas Processors expects to borrow $800,000 for field engineering improvement. Two methods of debt financing are possible borrow it all from bank or issue debenture bonds. The company will pay an effective 8% compound per year for 8 years to the bank. The principal on the loan will be reduced uniformly over the 8 years, with the remainder of each annual payment going toward interest. The bond issue will be 800 10-year bonds of S1000 each that require a 6% per year interest payment.
(a) Which method of financing is cheaper after an effective tax rate of 40% is considered?
(b) What is the cheaper method using a before-tax analysis?
10.25 Charity Hospital, established in 1895 as a nonprofit corporation, pays no taxes on income and receive no tax advantage for interest paid. The board of directors has approved expanded cancer treatment equipment that will require $10 million in debt capital to supplement $8 million in equity capital currently available. The $10 million can be borrowed at 7.5% per year through the Charity Hospital Corporation, Alternatively, 30-year trust bonds could be issued through the hospitals for-profit outpatient corporation, Charity Outreach, Inc. The interest on the bonds is expected to be 9.75% per year is tax-deductible. The bonds will be sold at a 2.5% discount for rapid sale. The effective tax rate of Charity Outreach is 32%, which form of debt financing is less expensive after taxes?
Cost of Equity Capital
10.26 Common stocks issued by Henry Harmon Builders paid stockholders $0.93 per share on an average price of S18.80 last year. The company expects to grow the dividend rate at a maximum of 1.5% per year. The stock volatility of 1.19 is somewhat higher than that of other public firms in the construction industry, and other stocks in this market are paying an average of 4.95% per year dividend. U.S. Treasury bills are returning 4.5% determine the company's cost of equity capital last year, using (a) the dividend method and (b) the CAPM.
10.37 Government regulations from the U.S. Department of Agriculture. (USDA) re-quire that a Fortune 500 corporation implement the .HACCP (Hazards Analysis and Critical. Control Points) loud safety program in its beef processing plants in 21 states. To finance the equipment and personnel training portions of this new program. Wholesome Chickens expects to use a D-E mix of 60%-40%: to finance a $10 million effort for improved equipment, engineering, and quality control. After-tax cost of debt, capital for loans is known to be 9.5% per year, However, obtaining sufficient equity capital will require the sale of common stock. as well as the commitment of corporate retained earnings. Use the following information to determine the WACC for the implementation of HACCP
Common stock: 100,000 shares
Anticipated price = $32 per share
Initial Dividend = $1.10 per share
Dividend Growth per share = 2% annually
Retained earnings: same cost of capital as for common stock
10.28 Last year a Japanese engineering materials corporation. Yamachi Inc. purchased same U.S. Treasury bonds that return an average of 4% per year. Now. Euro bonds are being purchased with a realized average return of 3.9% per year. The volatility factor of Yamachi stock last year was 1.10 and has increased this year to 1.18. Other publicly traded stocks in this same business are paying an average of 5.1% dividends per year. Determine the cost of equity capital for each year and explain why the increase or decrease seems to have occurred.
10.29 An engineering graduate plans to purchase a new car. He has not decided how in pay the purhase price of $28,000 for the SUV he has selected. He has the total available in a savings account, so paying cash is an option: however, this would deplete virtually all his savings. These funds return an average of 6% per year, compounded every 6 months. Perform a before-tax analysis to determine which or the three financing plans below has the lowest WACC.
Plan 1: D-E is 50%-50%
Use$14,000
from the savings account and borrow $14.000 at a rate of 7% per year. Compounded monthly. The difference between the payments and the savings would be deposited at 6% per year, compounded semi-annually.
Plan 2: 100% equity. Take $28,000 from savings now. Plan 3: 100% debt. Borrow $28,000 now from the credit union at an effective rate of 0.75% per month and repay the loan at $581.28 per month for 60 months.
10.30 OI Logistics.com has a total of 1.53 million shares of common stock outstanding at a market price of $28 per share. The before-tax coat of equity capital of common stock is 15% per year. Stocks fund 50% of the company's capital projects. The remaining capital is generated by equipment trust bonds and slum-term loans. Thirty percent of the debt capital is from $5,000,000 worth of $10,000 6% per year 15-year bonds. The remaining 70% of debt capital is from loans repaid at an effective 10.5% before taxes. If the effective income tax rate is 35%, determine the weighted average cost of capital (a) before taxes and (b) alter taxes.
10.31 Three projects have been identified. Capital will be developed 70% from debt sources at an average rate of 7.0% per year and 30% from equity sources at 10.34% per year. Set the MARR equal to WACC and make the economic decision, if the projects are (a) independent and (b) mutually exclusive. Annual Net Cash Initial Flow, Salvage life, Project Investment, S S/year Value, $ Years
|
Project |
Initial Investment, $ |
Flow, $/ Year |
Salvage Value, $ |
Life, Years |
|
1 |
-25,000 |
6,000 |
4,000 |
4 |
|
2 |
-30,000 |
9000 |
-1000 |
4 |
|
3 |
-50,000 |
15,000 |
20,000 |
4 |
10.32 Shadowland, a manufacture of air freight able pet crates, has identified two projects that, though having a relatively high risk are expected to move the company, into new revenue markets. Utilize a spreadsheet solution (a) to select any combination of the projects if MARR = after-tax WACC and (b) to determine if the same projects should be selected if the risk factors are enough to require an additional 2% per year for the investment to be made.
|
Project |
Initial Investment, $ |
Tax cash flow per year, $/year |
Life, Years |
|
Wildlife (W) |
-250,000 |
48,000 |
10 |
|
Reptiles ( R) |
-125,000 |
30,000 |
5 |
Financing will be developed using a D-E mix of 60-40 with equity funds costing 7.5% per year. Debt financing will be developed from $10,000 5% per year, paid quarterly, 10-year bonds. The effective tax rate is 30% per year.
10.33 The federal government imposes requirements upon industry in many areas, such as employee safety. Pollution control environment protection and noise control. One view of these regulations is that their compliance tends to decrease the return can investment and/or increase the cost of capital to the corporation. In many cases the economics of these regulated compliances cannot be evaluated as regular engineering economy alternatives. Use your knowledge of engineering economic analysis to explain how an engineer might canonically evaluate alternatives that define the ways in which the company will comply with imposed regulations.
Different D-E Mixes
10.34 Why is it financially unhealthy for an individual to maintain a large percentage of debt financing over a long period of time. That is, to be highly debt-leveraged?
10.35 Fairmont Industries primarily relies on 100% equity financing to Fund projects. A good opportunity is available that will require $250.000 in capital. The Fairmont owner can supply the money from personal investments that currently earn an average of 8.5% per year. The annual net cash flow from the project is estimated at $30,000 for the next 15 years. Alternatively, 60% of the required amount can be borrowed for 15 years at 9% per year. If the MARR is the WACC, determine which plan, if either, is better. This is a before tax analysis.
10.36 Mrs. McKay has different. methods by which a $600,000 project can be funded, using debt and equity capital. A net cash flow of $90,000 per year is estimated for 7 years.
|
Type of Financing |
Financing Plan % |
Cost per Year. % |
||
|
1 |
2 |
3 |
||
|
Debt |
20 |
50 |
60 |
10 |
|
Equity |
80 |
50 |
40 |
7.5 |
Determine the rate of return for each plan, and identify the ones that are economically acceptable if (a) MARR equals the cost of equity capital, (b) MARR equals the WACC, or MARR is halfway between the cost or equity capital and the WACC.
10.37 Mosaic Software has an opportunity to invest $10.000,000 in a new engineering remote-control system for offshore drilling platforms. Financing for mosaic will be split between common stock sales ($5,000,000) and a loan with an 8% per year interest rate, Mosaic share of the annual net cash flow is estimated to be $2.0 million for each of the next 6 years, Mosaic is about to initiate CAPM as its common stock evaluation model. Recent analysis shows that it has a volatility rating of 1.05 And is paying a premium of 5% common stock dividend. The U.S. Treasury bills are currently paying 4% per year. Is the venture financially attractive if the MARR equals (a) the cost of equity capital and (b) the WACC'?
10.38 Draw the general shape of the three cost of capital curves (debt, equity, and WACC). using the form of Figure 10-2. Draw them under the, condition that high D-E mix has been present for some time for the corporation. Explain via your graph and words the movement of the minimum WACC point under historically high leveraged D-E mixes. Hint: High D-E mixes cause the debt cost to increase substantially. This makes it harder to obtain equity funds, SO the cost of equity capital also increases.
10.39 In a leveraged buyout of one company by another, the purchasing company usually obtains borrowed money and insert as kittle of its own equity funds as possible into the purchase. Explain some circumstances under which such a buy-out may put the purchasing company at economic risk.
Multiple-Attribute Evaluation
10.40 A committee of four people submitted the following statements about the at-tributes to be used in a weighted attribute method. Use the statements to determine the normalized weights if scores are assigned between 0 and 10.
|
Attribute |
Comment |
|
1. Flexibility |
The most important factor |
|
2. Safety |
50% as important as uptime |
|
3. Uptime |
One-half as important as flexibility |
|
4. Speed |
As important as Uptime |
|
5. Rate of Return |
Twice as important as safety |
10.41 Different types and capacities or crawler hoes are being considered for use in major' excavation on a pipe-laying project. Several supervisors on similar projects of the past have identified some of the attributes and their views of the importance of an attribute. 'The information has been shared with you. Determine the weighted rank order, using a 0 to 100 scale and the normalized weights.
|
Attribute |
Comment |
|
Truck versus hoe loading beight |
Vitally important factor |
|
Type of lopsoil |
Usually only 10% of the problem |
|
Type of soil below topsoil |
One half as important as matching trenching and laying speeds |
|
Hoe cycle time |
About 75% as important as soil type below topsoil |
|
Match hoe trenching speed to pipe-laying speed |
As important as attribute number one |
10.42 You graduated 2 years ago, and you plan to purchase a new car. For three different models you have evaluated the initial cost and estimated annual costs for fuel and maintenance. You also evaluated the styling of each ear in your role as a young engineering professional. List some additional 'factors (tangible and in-tangible) that might be used in your version of the weighted attribute method.
10.43 (Note to instructor): This and the next two problems may be assigned as a progressive exercise John who works at Swatch has decided to use the weighted attribute method to compare three system for manufacturing a watchband. The vice president and her assistant bave evaluated each of three attributes in terms of importance to them, and john has placed an evaluation from 0 to 100 on each alternative for the three Attributes. John’s ratings are as follows:
|
Attribute |
1 |
2 |
3 |
|
Economics return > MARR |
50 |
70 |
100 |
|
High throughput |
100 |
60 |
30 |
|
Low Scrap rate |
100 |
40 |
50 |
Use the weights below to evaluate the alternatives. Are the results the same for the two persons' weights' Why?
|
Important Score |
VP |
Assistant VP |
|
Economics return > MARR |
20 |
100 |
|
High throughput |
80 |
60 |
|
Low Scrap rate |
100 |
20 |
10.44 In Problem 10.43 the vice president and assistant vice president are not consistent in their weights of the three attributes. Assume you are a consultant asked to assist John.
(a) What are some conclusions yon can draw about the weighted attribute method as an alternative selection method, given the alternative ratings and results in Problem 10,437•
(b) Use the new alternative rating below that you have developed yourself to select an alternative. Using the same scores as the vice president and her assistant given in Problem 10.43 comment on any difference in the alternative selected.
(c) What do your new alternative ratings tell you about the selections based on the importance scores of the vice president and assistant vice president?
|
Attribute |
1 |
2 |
3 |
|
Economics return > MARR |
30 |
40 |
100 |
|
High throughput |
70 |
100 |
70 |
|
Low Scrap rate |
100 |
80 |
90 |
10.45 The watchband division discussed in Problems 10.43 and 10.44 has just been lined $1 million for environmental pollution due to the poor quality of its dis-charge water. Also. John has become the vice president and there is no longer an assistant vice president. John always agreed with the importance scores of the Cornier assistant vice president and the alternative ratings he developed earlier (those present initially in Problem 10.43 If he adds his own importance. score of 80 to the new factor of environmental cleanliness and awards alternatives lives 1, 2, and 3 ratings of 80, 50. and 20. respectively for this new factor. redo the evaluation to select the best alternative.
10.46 For Example 10.10, use an equal weighting of 1 for each attribute to choose the alternative. Did the weighting of attributes change the selected alternative?
10.47 The Athlete's Shop has evaluated two proposals for weight lifting and exercise equipment. A present worth analysis at 15% of estimated incomes and costs resulted in PW, = $420.500 and PW8 = $392.800. In addition to this economic measure, three attributes were independently assigned a relative importance score from 0 to 100 by the shop manager and the lead trainer.
|
Attribute |
Manager |
Trainer |
|
Economics |
100 |
80 |
|
Durability |
35 |
10 |
|
Flexibility |
20 |
100 |
|
Maintainability |
20 |
10 |
Separately, you have used the four attributes to rate the two equipment proposals on a scale of 0.0 to 1.0. The economics attribute was rated using the PW values.
|
Attribute |
Proposal A |
Proposal B |
|
Economics |
1.00 |
0.90 |
|
Durability |
0.35 |
1.0 |
|
Flexibility |
1.00 |
0.90 |
|
Maintainability |
0.25 |
1.00 |
Select die better proposal, using each of the following methods.
(a) Present worth (b) Weighted evaluations of the manager (c) Weighted evaluations or the lead trainer
EXTENDED EXERCISE
EMPHASIZING THE RIGHT THINGS
A fundamental service provided to the citizens of a city is police protection. Increasing crime rates that include injury to persons have been documented in the close-in suburbs in Belleville. a densely populated historic area north of the capital. In phase I of the effort the police chief has made and preliminarily examined four proposals of ways in which police surveillance and protection may be pro-vided in the target residential areas, in brief, they are placing additional officers in cars- on bicycle on foot, or on horseback. Each alternative, has been evaluated separately to estimate annual costs. Placing six new officers on bicycles is clearly the least expensive Talon at an estimated $700,000 per year. The next best is on foot with 10 new officers at $925.000 per year. The other alternative% will cost ,slightly more than the "on foot" option.
Before entering phase It which is a 3-month pilot study to test one or two of these approaches in the neighborhoods. a committee of five members (comprised of police staff and citizen-residents) has been asked to help determine and prioritize attributes that are important in this decision to them, as representatives of the residents and police officers. The five attributes agreed upon after 2 months of discussion are listed below. Followed by each committee member's ordering of the attributes from the most important (a score of 1) to the least important La score 5).
|
Attribute |
1 |
2 |
3 |
4 |
5 |
Sum |
|
Ability to become ‘close’ to the citizenry |
4 |
5 |
3 |
4 |
5 |
21 |
|
Annual Cost |
3 |
4 |
1 |
2 |
4 |
14 |
|
Response time upon call or dispatch |
2 |
2 |
5 |
1 |
1 |
11 |
|
Number of Blocks in coverage area |
1 |
1 |
2 |
3 |
2 |
9 |
|
Safety of Officers |
5 |
3 |
4 |
5 |
3 |
20 |
Questions
1. Develop weights that can be used in the weighted attribute method for each attribute. The committee members have agreed that the simple average of their live ordered-attribute scores can be considered the indicator of how important each attribute is to them as a group.
2. One committee member recommended, and obtained committee approval for, reducing the attributes considered in the final selection to only those that were listed as number I by one or more committee members. Select these attributes and recalculate the weights as requested in question 1.
3. A crimes prevention analyst in the Police Department applied the weighted attribute method to the ordered attributes in question 1. The R1 values obtained using Equation DAM ate listed below. Which two options should the police chief select for the pilot study?
|
Alternative |
Car |
Bicycle |
Foot |
Horse |
|
R1 |
62.5 |
50.5 |
47.2 |
35.4 |
CASE STUDY
WHICH WAY TO GO DEBT OR EQUITY FINANCING?
The Opportunity
Pizza Hut Corporation bus decided to enter the catering business in three states within its Southeastern US. Division, using the name Pizza Hut At-Your-Place. To deliver the meals and serving personnel, it is about to purchase 200 vans with custom interiors for a total or $1.5 million. Each van is expected to be used for 10 years and have a $1000 salvage value.
A feasibility study completed last year indicated that the At-your-Place business veture could realize an estimated annual net cash flow of $300,000 before taxes in the three states. After-tax considerations would have to take into account the effective tax rate or 35% paid by Pizza Hut.
An engineer with Pizza Huts Distribution Division has worked with the corporate finance office to deter-mine how to best develop the $1.5 million capital needed for the purchase of vans. There are two viable financing plans
The Financing' Options
Plan A is debt financing for 50% or the capital ($750,000) with the 8% per year compound interest loan repaid over 10 year with uniform year-end payments. (A simplifying assumption that $75,000 of the principal is repaid with each annual payment can be made.)
Plan B is 100% equity capital raised from the sale of $15 per share common stock. The financial manager informed the engineer that stock is paying $0.50 per share in dividends and that this dividend rate has been increasing at an average of 5% each year. This dividend pattern is expected to continue, based on the current financial environment.
Case Study Exercises
1. What values of MARR should the engineer use to determine the better financing plan?
2. The engineer must make a recommendation on the financing plan by the end of the day. He does not know how to consider all the tax angles for the debt financing in plan A. However, he does have a handbook that gives these relations for equity and debt capital about taxes and cash flows:
Equity Capital: no income tax advantages
After-tax net cash flow (before tax. net cash flow)(1 Tax rate) Debt- capital: income tax advantage comes from interest paid on loans
After-tax net cash flow = before-tax net cash now - loan principal - Joan interest - taxes
Taxes= (taxable income) (tax rate)
Taxable income= net cash flow - loan interest
He decides to forget any other tax consequences and use this information to prepare a recommendation. Is A or B the better plan?
3. The division manager would like to know how much the WACC varies for different D-E mixes, especially about 15% to 20% on either side of the 50% debt financing option in plan A, Plot the WACC curve and compare its Shape with that of Figure 10-2.
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