Spartan Corporation estimates that there is 25% chance of a recession economy next year, a 50% chance of a normal economy next year, and a 25% chance of a boom economy next year. The corporation will exist until the end of next year and then it will cease to exist. Spartan has $80 of debt that must be repaid next year. Assume a 0% discount rate for all cash flows (in other words, there is no discounting). (a) Spartan has a low risk project that yields a cash flow of $70 in a recession, $100 in a normal economy, and $130 in a boom. If Spartan chooses this low risk project: (i) what is the value of Spartanâs debt? (ii) what is the value of Spartanâs equity? (b) Spartan has a high risk project that yields a cash flow of $30 in a recession, $100 in a normal economy, and $160 in a boom. If Spartan chooses this high risk project: (i) what is the value of Spartanâs debt? (ii) what is the value of Spartanâs equity? (c) Which project will Spartan choose? Given your answers to (a) and (b), when Spartan sells the bonds would it like to include a covenant that would prohibit it from taking the high-risk project? Explain your answer.
Spartan Corporation estimates that there is 25% chance of a recession economy next year, a 50% chance of a normal economy next year, and a 25% chance of a boom economy next year. The corporation will exist until the end of next year and then it will cease to exist. Spartan has $80 of debt that must be repaid next year. Assume a 0% discount rate for all cash flows (in other words, there is no discounting). (a) Spartan has a low risk project that yields a cash flow of $70 in a recession, $100 in a normal economy, and $130 in a boom. If Spartan chooses this low risk project: (i) what is the value of Spartanâs debt? (ii) what is the value of Spartanâs equity? (b) Spartan has a high risk project that yields a cash flow of $30 in a recession, $100 in a normal economy, and $160 in a boom. If Spartan chooses this high risk project: (i) what is the value of Spartanâs debt? (ii) what is the value of Spartanâs equity? (c) Which project will Spartan choose? Given your answers to (a) and (b), when Spartan sells the bonds would it like to include a covenant that would prohibit it from taking the high-risk project? Explain your answer.
Related questions
DataPoint Engineering is considering the purchase of a new piece of equipment for $410,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $230,000 in nondepreciable working capital. Seventy-seven thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12â11, Table 12â12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
| Year | Amount | ||||
| 1 | $ | 236,000 | |||
| 2 | 194,000 | ||||
| 3 | 164,000 | ||||
| 4 | 149,000 | ||||
| 5 | 112,000 | ||||
| 6 | 102,00 | ||||
The tax rate is 30 percent. The cost of capital must be computed based on the following:
| Cost (aftertax) | Weights | ||||||||
| Debt | Kd | 10.20 | % | 30 | % | ||||
| Preferred stock | Kp | 12.50 | 20 | ||||||
| Common equity (retained earnings) | Ke | 19.00 | 50 | ||||||
a. Determine the annual depreciation schedule.
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The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $100,000. Of this amount, $80,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $20,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. The contract will require an additional investment of $42,000 in working capital at the beginning of the first year and, of this amount, $22,000 will be returned to the Spartan Technology Company after six years. The investment will produce $40,000 in income before depreciation and taxes for each of the six years. The corporation is in a 30 percent tax bracket and has a 15 percent cost of capital
. a. Calculate the net present value
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