Blank L., Tarquin A. Engineering Economy (McGraw-Hill Series in Industrial Engineering and Management)
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J 0.16 Tiffany Baking Co. wants to arrange for
$50 million in capital for manufacturing
a new consumer product. The current
fi-
nancing plan
is
60% equity capital and
40% debt financing. Compute the WACC
for the following financing scenario.
10
.
17
Plan
1
2
3
4
5
6
7
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 remain-
ing
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
conveltible bonds at an estimated
10% per year bond interest rate.
The
possible D-E mixes and costs
of
debt and equity capital for a new project
are summarized 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 eq-
uity capital will result
in
the lowest WACC.
Debt
Capital Equity Capital
Percentage
Rate, %
Percentage
Rate, %
100 14.5
70 13.0 30 7.8
65
12.0
35
7.8
50 11.5 50
7.9
35
9.9
65
9.8
20 12.4
80
12.5
100 12.5
10
.
18
For Problem 10.17, use a 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
PROBLEMS
375
you own has averaged a total return
of
6% per year over the last 3 years. The an-
nual 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 cap-
ital from a tax perspective in the
United
States, determine the before-tax and
after-tax weighted average costs
of
capi-
tal
if
a project is funded 40
%-60%
with
debt capital borrowed at 9% per year. A
recent study indicates that corporate eq-
uity funds earn 12% per year and that the
effective tax rate is 35% for the year.
Cost
of
Debt
Capital
10.21
10.22
Bristol Myers Squibb, an international
pharmaceutical company, is initiating a
new project for which it requires $2.5 mil-
lion in debt capital. The current plan
is
to
sell20-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.
The Sullivans' plan to purchase a refur-
bished condo in their parents' hometown
for investment purposes. The negotiated
$200,000 purchase price will be financed
with
20%
of
their savings which con-
sistently make 6.5% per year after all rele-
vant 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 Sullivans' annual loan
payment for each
of
the
15
years?
376
CHAPTER
10
Making Choices:
The
Method, MARR, and Multiple Attributes
(b) What
is
the net present worth dif-
ference between the
$200,000 now
and the
PW
of
the cost
of
the
80-20
D-E mix series
of
cash flows nec-
essary 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 proj-
ect 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
] 00% equity finance the
project. An alternative financing strategy
is to issue $4
mi
ll
ion worth
of
lO-year
bonds that
wi
ll
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
improvements. Two methods
of
debt
fi-
nancing are
possible-borrow
it all from
a bank or issue debenture bonds. The
company will pay an effective 8% com-
pounded per year for 8 years to the bank.
The
principal on the loan will be reduced
uniformly over the 8 years, with the re-
mainder
of
each annual payment going
toward interest. The bond issue will be
800 IO-year bonds
of
$1000 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 receives 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 Corpo-
ration. Alternatively, 30-year trust bonds
could be issued through the hospital's
for-profit outpatient corporation, Charity
Outreach, Inc.
The
interest on the bonds
is expected to be 9.75% per year, which
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 Har-
mon Builders paid stockholders
$0.93
per
share on an average price
of
$18.80
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 pub-
lic 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.
10.27 Government regulations from the U.S.
Department
of
Agriculture (USDA) re-
quire that a Fortune
500 corporation im-
plement the
HACCP
(Hazards Analysis
and Critical Control
Points) food 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 equip-
ment, 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
sa
le
of
common stock, as well
as the
co
mmitment
of
corporate retained
earnings.
Use the following information
to determine the WACC for the imple-
mentation
of
HACCP.
Common
stock: 100
,000
shares
Anticipated price
=
$32
per share
Initial
di
vidend = $ 1.10 per s
har
e
Dividend
growt
h
per share
= 2% annually
Retained
ea
rnings: same
cost
of
capital
as
for
common
stock
10.28 Last year a Japan
ese
engineering materi-
als corporation, Yamachi Inc., purchased
some
U.S. Treasury bonds that return an
aver
age
of
4% per year. Now, Euro bonds
are being purchased with a realized aver-
age r
et
urn
of
3.9% per year.
The
volatil-
ity factor
of
Yamachi stock last year was
1.1
0 and has increased this
year
to 1.18.
Other publicly traded stocks in this
sa
me
business are pay
in
g an average
of
5.1 %
di
v
id
e
nd
s per year. Det
erm
ine the cost
of
equity capital for each year, and explain
why the increa
se
or
decrease seems to
have occurred.
10.29 An eng
in
eer
ing
gra
duat
e plans to pur-
chase a n
ew
car.
He
has not
de
cided h
ow
to pay
th
e purchase price
of
$28,000
for
th
e
SUV
he has
se
l
ec
ted.
He
has the total
ava
il
able in a sav
in
gs account, so
pa
ying
cash is an option;
how
ever, this would
deplete virtually all his savings.
Th
ese
funds return an average
of
6%
per year,
compounded every 6 months.
Perform a
before-tax analysis to d
eterm
ine which
of
the three financing plans below has
the lowest
WACC.
PLan}:
D-E
is
50%-50%.
Use
$14,
000
from the savings account and bor-
row
$
14
,000 at a rate
of
7% per
year,
co
mpounded monthl
y.
The
diff
erence b
et
w
ee
n the payments
PROBLEMS 377
and the savings would
be
deposited
at
6%
per year,
compounded
semi-
annually.
Plan
2:
100%
equity. Take
$28,0
00
from
savings now.
Plan 3:
100
% debt.
Borrow
$28,000
now from the credit union at an ef-
fective rate
of
0.75%
per
month
,
and repay the loan at
$58l.28
per
month
for
60
months.
10.30 OILogistics.com has a total
of
1.53 mil-
lion shares
of
common
stock outstanding
at a
market
price
of
$2
8 per s
har
e.
The
before-tax
cost
of
equity capital
of
co
m-
mon sto
ck
is 15% per year. Stocks fund
50%
of
the
company
's capital projects.
The
remaining capital
is
generate
d by
equipment
trust
bond
s and s
hort
-term
loans. Thirty percent
of
the
debt
capital
is from
$5,
000
,
000
worth
of
$10,00
0
6% per
year
IS-year
bonds.
The
remain-
ing
70
%
of
de
bt
capital is from loans re-
paid at an effective 10.5% before taxes.
If
the effective
income
tax rate is 35%, de-
termine the weighted average cost
of
cap-
ital
(a) before taxes
and
(b) after taxes.
10
.31
Three
projects h
ave
be
en identified.
Project
2
3
10.
32
Capital will be d
eve
loped
70
% f
rom
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
deci-
sion,
if
the
pr
ojec
ts are (a) independent
and
(b) mutually exclusive.
Annual
Net
Cash
Initial
Flow,
Salvage
Life,
Investment,
$
$/year
Value, $ Years
- 25,000
6,000 4,000
4
-30,
000
9,000
- 1
,0
00
4
-5
0,000
15
,000 20,000 4
Shadowland,
a manufacturer
of
air-
freightable pet crates, has identified two
378
CHAPTER
10
Making Choices: The Method, MARR, and Multiple Attributes
Project
projects that, though having a relatively
high risk, are expected
to
move the com-
pany into new revenue markets. Utilize a
spreadsheet solution
(a)
to
select any com-
bination
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.
Estimated
After-
Initial Tax Cash Flow
Life,
Investment,
$
per
Yea
r,
$/year
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, lO-year bonds. The
effective tax rate
is
30% per year.
10.33
The
federal government imposes require-
ments upon industry in many areas, such
as employee safety, pollution control, en-
vironmental protection, and noise control.
One view
of
these regulations is that their
compliance tends to decrease the return
on investment and/or increase the cost
of
capital to the corporation. In many cases
the economics
of
these regulated com-
pliances cannot be eva
lu
ated
as
regular
engineering economy alternatives.
Use
your knowledge
of
engineering economic
analysis to explain how
an
engineer might
economically 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 in-
dividual to maintain a large percentage
of
debt financing over a long period
oftime
,
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
Fair-
mont 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
esti-
mated 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.
Financing Plan, %
Type
of
Financing 1
2
3
Cost
per
Year, %
Debt
Equity
10.37
20
80
50
50
60
40
10
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
(c)
MARR
is
halfway between the cost
of
equity capital and the WACC.
Mosaic Software has an opportunity to
invest
$10,000,000 in a new engineer-
ing 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's 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 s
how
s that it has a volatility rat-
ing of
1.05 and is paying a premium
of
5%
comm
on stock dividend.
The
U.S.
Treasury bills are c
UI
Tently paying
4%
per year. Is the venture financia
ll
y attrac-
tive
if
the
MARR
equals (a) the
cost
of
equity capital a
nd
(b) the
WACC?
10.38
Draw
the
ge
neral shape
of
the three
cost
of
capital curves (debt, equity, and
WACC), using the form
of
Figure 10
-2.
Draw them under the
co
ndition that a
hi
gh D
-E
mix has b
ee
n
pr
ese
nt for some
time for the corporation. Explain via
your graph and wo
rd
s the movement
of
the
minimum
WACC point under histor-
ically high leveraged
D-E
mixes. Hint:
High
D-E
mixes cau
se
the
debt
cost
to
increase substantia
ll
y.
This
makes it
harder to obta
in
equity funds, so the cost
of
equity
cap
ital also
in
creases.
10.39
Tn
a l
ever
aged buyout
of
one
comp
any
by another,
th
e purchas
in
g
company
usually obtains borrowed money and in-
serts as little
of
its own equity funds as
possible into the purchase.
Exp
lain 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 p
eop
le submitted
the fo
ll
ow
ing state
ment
s about the at-
tributes to be used
in
a weighted attribute
method.
Use
th
e statements to determine
the normalized weights
if
scores are
assigned be
twe
en 0 and
10.
Attribute
I.
Flex ib
ili
ty
2. Safety
3. Uptime
4. Speed
5. Rate
o
f"
return
Comment
The
most important factor
50
% as important as uptime
One-half as important as flex ibility
As important as uptime
Twice as importa
nt
as safety
PROBL
EMS
379
10.41 Different types and capacities
of
craw
l
er
hoes are being considered for use in a
major excavation on a pipe-laying pro-
ject. Several supervi
so
rs on similar pro-
jects
of
the past
have
identified so
me
of
the attributes and their views
of
the
im
-
portance
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
I. Truck versus hoe
load
in
g height
2. Type
of
topsoil
3. Type
of
so
il
below
topsoil
4. Hoe cycle time
5. Match hoe trenching
spee
d to pipe-laying
speed
Comment
Vitally important factor
Usua
ll
y o
nl
y
10
%
of
the problem
One-ha
lf as important
as match
in
g trench
in
g
and laying
spee
ds
About 75% as impo
rt
ant
as so
il
type bel
ow
topsoil
As important as attri
but
e
numb
er one
10.42 You graduated 2 years ago, and you plan
to purchase a n
ew
car.
For
three different
models you h
ave
eva
luated the initial
cost
and
estimated
annual
cost
s for fuel
and maintenance. You also evaluated the
st
yling
of
each
car
in
your
role as a
young
engi n
ee
ring professional. List
some additional factors (tangible and in-
tangible) that
might be u
se
d in
your
ver-
sion
of
the weighted attribute method.
10.43 (Note to instructor:
This
and the next
two problems
may
be
assigned as a pro-
gressive exercise.)
John
,
who
works at
Swatch
, has decided to u
se
the weighted
attribute
method
to
compare
three sys-
tems for manufacturi ng a watchband.
The vice president and her assistant have
evaluated each of three attributes in
terms
of
importance to them, and John
has placed an evaluation from
0 to 100
380
CHAPTER
10
Making Choices: The Method,
MARR,
and
Multiple
Attributes
on each alternative for the three attrib-
utes. John
's
ratings are as follows:
Alternatives
Attribute
2 3
Economic return >
MARR
50
70
100
High throughput
100
60
30
Low
sc
rap
rate
100
40
50
Use the weights below to evaluate the al-
ternatives. Are the results the
same
for
the
two
persons' weights?
Why?
Importance
Score
VP
Assistant
VP
Economic return >
MARR
20
100
80
20
High throughput
80
Low
scrap
rate
100
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 you can
draw about the weighted attribute
method as an alternative selection
method, given the alternative rat-
ings and results
in
Problem 10.43?
(b) Use the new alternative ratings
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 dif-
ferences
in
the alternative selected.
(c)
What
do
your new alternative rat-
ings tell you about the selections
based on the importance scores
of
the vice president and assistant vice
president?
Alternatives
Attribute
2 3
Economic return >
MARR
30
40
100
High throughput
70
100
70
Low
sc
r
ap
rate
100
80
90
10.45
The
watchband division discussed in
Problems 10.43 and 10.44 has
just
been
fined
$1
million for environmental pol-
lution 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
former 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
environ-
mental cleanliness and awards alterna-
tives 1
,2,
and 3 ratings
of80,
50, and 20,
respectively, for this new factor, redo the
evaluation to select the best alternati ve.
10.46
10.47
For
Example
10.10, use an
eq
ual weight-
ing
of
1 for each attribute to
choose
the
alternative. Did the weighting
of
attrib-
utes change the selected alternative?
The
Athlete's
Shop
has evaluated two
proposals for weight lifting and exercise
equipment. A present worth analysis at
i = 15%
of
estimated incomes and costs
resulted in
PW
A = $420,500 and
PW
B =
$392,800. In addition to this economic
measure, three attributes were indepen-
dently assigned a relative importance
score from
0 to 100
by
the shop manager
and the lead trainer.
Attribute
Economics
Durability
Flexibility
Maintainability
Importance
Score
Manager
Trainer
100
35
20
20
80
10
100
10
Separately, you have used the four attrib-
utes to rate the two
equipment
proposals
on a scale
of
0.0 to 1.0.
The
economic
attribute was rated using the
PW
values.
EXTENDED
EXERCISE
38
1
Attribute
Proposal
A
Economics
1.00
Proposal
B
0.90
Select the better proposal, using each
of
the following methods.
Durability 0.35 1.00
Flexibility 1.00 0.90
Maintainability 0.25 1.00
EXTENDED EXERCISE
EMPHASIZING THE RIGHT THINGS
(a) Present worth
(b) Weighted evaluations
of
the man-
ager
(c) Weighted evaluations
of
the lead
trainer
A fundamental service provided to the citizens
of
a city is police protection. In-
creasing crime rates that include injury to persons have been documented in the
close-in suburbs
in
Bellev
ill
e, a dense
ly
populated historic area north
of
the cap-
ital. 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 bicycles, on foot,
or
on horseback. Each alternative has been evalu-
ated separately to estimate annual costs.
Placing six new officers on bicycles is
clearly the least expensive option at an estimated
$700,000 per year.
The
next
best is on foot with
10
new officers at $925,000 per year.
The
other alternatives
will cost slightly more than the
"on foot" option.
Before entering phase II, 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 a
nd
citizen-residents) has been asked to help determine and prior-
itize 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
li
sted below, followed by each committee member's ordering
of
the attributes from the most important (a score
of
1) to the least important
(a score
of
5
).
Committ
ee
Mem
be
r
Attribute
1 2
3
4 5 Sum
A. Ab
ili
ty to
become
'
close
' to the citiz
enry
4 5
3
4 5
21
B. Annual
cost
3
4 2 4 14
C.
Respon
se
time upon
ca
ll
or dispatch 2 2 5
I I
II
D.
Number
of
bl
oc
ks
in
cove
r
age
area
I 1
2 3
2
9
E.
Saf
ety of officers 5 3
4
5 3
20
Totals
15
15 15
15 15
75
382
CHAPTER
10
Making Choices: The Method, MARR, and Multiple Attributes
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 five 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 ap-
proval for, reducing the attributes considered in the final selection to
only those that were listed as number
I by one or more committee mem-
bers. Select these attributes and recalculate the weights as requested
in
question
l.
3. A crimes prevention analyst in the Police Department applied the weighted
attribute method to the ordered attributes in question
1.
The R
j
va
lu
es
obtained using Equation [10.11] are listed below. Which two options
should the police chief select for the pilot study?
Alternative
Bicycles
Horse
50.5
35.4
r
--
.......
-
CASE
STUDY
WHICH
WAY
TO
GO-DEBT
OR EQUITY FINANCING?
The Opportunity
Pizza Hut Corporation has decided
to
enter the cater-
ing business
in
three states within its Southeastern U.S.
Divis
ion
, using the name Pizza Hut At-Your-Place.
To
deliver the m
ea
ls and serving personnel,
it
is about
to
purchase 200 vans with custom interiors for a total
of
$1.5 million. Each van
is
expected to be used for
10
years a
nd
have a $1000 salvage value.
A feasibility study completed last year indicated
that the At-Your-Place business venture
cou
ld realize
an estimated annual net cash flow
of
$300,000 before
taxes
in
th
e three states. After-tax considerations
wou
ld
have
to
take into account the effective tax rate
of
35% paid by Pizza Hut.
An
engineer with Pizza
Hut's
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
%
of
the capital
($750,000) with the 8% per year compound interest
loan repaid over 10 years with uniform year-end pay-
ments. (A simplifying assumption that
$75,000
of
the
principal is repaid with each annllal 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 divi-
dend pattern is expected
to
continue, based on the cur-
rent 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
CASE STUDY
383
After-tax net cash
flow
= before-tax net cash flow - loan principal
- loan 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 recommen-
dation. 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.
LEVEL
ONE
This
Is
How
It
- All Starts
hapter
2
Factors:
How
Time and
Interest Affect
Money
Chapter
3
Combining
Factors
Chapter
4
Nominal and
Effective
Interest Rates
\
"\)'
LEVEL
TWO
Tools
for
Evaluating
Alternatives
Chapter
5
Present Worth
Analysis
Chapter
6
Annual Worth
Analysis
Chapter
7
Rate
of
Return
Analysis: Single
Alternative
Chapter
8
Rate
of
Return
Analysis:
Multiple
Alternatives
Chapter
9
Benefit/Cost
Analysis and
Public Sector
Economics
Chapter
10
Making Choices:
The Method,
MARR,
and
Multiple
Attributes
LEVEL THREE
Making
Deci-
sions
on
Real-
World
Projects
Chapter
11
Replacement
and Retention
Decisions
Chapter
12
Selection
from
Independent
Projects Under
Budget
Limitation
Chapter
13
Breakeven
Analysis
LEVEL
FOUR
Rounding
Out
the
Study
Chapter
1
4:
Effects
of
Inflation
Chapter
15
Cost Estimation
and
Indirect
Cost Allocation
Chapter
16
Depreciation
Methods
Chapter
17
After-Tax
Economic
Analysis
Chapter
18
Formalized
Sensitivity
Analysis and
Expected
Value
Decisions
Decision Making
Under
Risk
'"