This assignment is to be completed in groups of three and carries 30 per-cent of the marks in this unit. There are three questions. See attached file.
1 Semester 3-2015 ASSIGNMENT
This assignment is to be completed in groups of three and carries 30 per-cent of the marks in
this unit. There are four questions.
Black Crow Company is evaluating a new widget with a life of 2 years. The widget costs
$3,000 and future after-tax cash flows depend on demand for the company's products. The
tabular illustration of a probability tree of possible future cash flows associated with the new
widget is as follows a) What are the joint probabilities of occurrence of the various branches?
b) If the risk-free rate is 10 per cent, what is (i) the net present value of each of the 6
complete branches; and (ii) the expected value and standard deviation of the probability
distribution of possible net present values? 2 Question 2.
Betcha Ltd is evaluating three investment situations: (1) produce a new line of widgets, (2)
expand its existing widget line to include several new sizes, and (3) develop a new higherquality line of widgets. If only the project in question is undertaken, the expected present
values and the amounts of investment required are as follows: If projects 1 and 2 are jointly undertaken, there will be no economies; the investment required
and present values will simply be the sum of the parts. With projects 1 and 3, economies are
possible in investment because one of the machines acquired can be used in both production
processes. The total investment required for projects 1 and 3 combined is $440,000. If
projects 2 and 3 are undertaken, there are economies to be achieved in marketing and
producing the products but not in investment. The expected present value of future cash flows
for projects 2 and 3 combined is $620,000. If all three projects are undertaken
simultaneously, the economies noted above will still hold. However, a $125,000 extension on
the plant will be necessary, as space is not available for all three projects.
Which project or projects should be chosen?
Crown Ltd operates outdoor amusement centres in a number of country towns. The company
has decided to build another centre that is expected to generate a permanent increase in EBIT
of $120,000 pa. Current EBIT is $375,000. Crown currently has a capital structure that
utilises bonds, ordinary equity and preference shares. The $220,000 of issued bonds pay 7%
pa. Preference shares pay an annual fixed dividend of $140,000. Currently 230,000 ordinary
shares have been issued and are trading at $3 per share. The company pays tax at 30%.
a) Crown needs to raise $720,000 to construct the new amusement centre. Assuming the
company can issue new shares at the current market price, what is the impact on EPS if
new shares are issued to fund the centre?
b) If new debt can be raised at a 9% interest rate, what is the impact on EPS of using debt
rather than a new equity issue?