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Reading 28: Capital Budgeting LOS i~ Q1-3

 

LOS i: Differentiate among, and evaluate a capital project using, the following valuation models: economic profit (EP), residual income, and claims valuation.

Q1. Charles Waller, a financial analyst for Vandon Pharmaceuticals, is evaluating a potential capital project for the firm. Waller’s favorite capital budgeting approach is the residual income method, which he decides to use for this project. In order to help with his analysis, Waller has compiled financial information concerning the project for 2006.

Project Income Statement
2006

Revenues

$56,000

Variable Expenses

$25,800

Fixed expenses

$6,000

Depreciation

$8,000

EBIT

$16,200

Interest expense

$5,000

EBT

$11,200

Taxes (40%)

$4,480

Net Income

$6,720

 

Project Balance Sheet
2005

Cost of Project

$80,000

Total Assets

$80,000

Project Financing

Debt

$32,000

Equity

$48,000

Total Liabilities and Equity

$80,000

Vandon Pharmaceuticals has an after-tax cost of debt of 6.0% and a cost of equity of 12.0%. Vandon’s target capital structure is 60% equity and 40% debt. Based on Waller’s information, what is the residual income for 2006, and what is the proper discount for Waller to use when finding the NPV of the investment?

          Residual income     Proper discount rate

 

A)   $5,760                                   9.6%

B)   $960                                      12.0%

C)   $960                                      9.6%

 

Q2. Firehouse Company is investing in a

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回复:(youzizhang)[2009] Session 8 -Reading 28: ...

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