(Solved)Prints Company is a medium-sized commercial printer ofpromotional


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Prints Company is a medium-sized commercial printer ofpromotional advertising brochures. The Company is currently having problemscost-effectively meeting run length requirements as well as meeting qualitystandards. The general manager has proposed to replace the current pressmachine with the purchase of one of two new presses designed forlong-high-quality runs, aiming to put the firm in a more competitive position.The key financial characteristics of the old press and the two proposed pressesare summarised below: Old press: Purchased 3 years ago at an installed costof $ 400,000. It has a remaining economic life of 5 years. It can be sold todayto net $ 420,000 before taxes. If it is retained, it can be sold to net $150,000 before taxes in at the end of 5 years. Press A: It can be purchased for $ 830,000, and willrequire $ 40,000 in installation costs. At the end of the 5 years, the machinecould be sold to net $ 400,000 before taxes. If the machine is acquired, it isanticipated that the following current account changes would result to: Cash : + $ 25,400 Account Receivable :+ $ 120,000 Inventories : – $ 20,000 Accounts Payable : + $ 35,000 Press B: It costs $ 640,000 and requires $ 20,000 ininstallation costs. At the end of the 5 years, the machine could be sold to net$ 330,000 before taxes. No effect is expected on the firm’s net working capitalinvestment. All presses (old and new) are depreciated underStraight line depreciation. The general manager estimates that firm’s earningsbefore depreciation, interest and taxes with the old and the new machines foreach of the 5 coming years would be: Year Old press Press A Press B 1 $ 120,000 $ 250,000 $ 210,000 2 $ 120,000 $ 270,000 $ 210,000 3 $ 120,000 $ 300,000 $ 210,000 4 $ 120,000 $ 330,000 $ 210,000 5 $ 120,000 $ 370,000 $ 210,000 The firm is subject to a 40% tax rate, the risk-freerate of return is 5.5%, the return in the market portfolio is 12.6% and thebeta coefficient for the company is 1.2. Finally, assume that theimmediate past 5 years the annual dividends paid on the firm’s common stockwere as follows: Year Dividend per share -1 $ 1.90 -2 $ 1.70 -3 $ 1.55 -4 $ 1.40 -5 $ 1.30 The general manager expects that without the proposedpurchase(s), the dividend in the coming year will be $ 2.09 per share and thehistorical annual rate of growth (rounded to the nearest whole percent) willcontinue in the future. With the purchase(s), it is expected that the dividendin the coming year will rise to $ 2.15 per share and the annual rate ofdividend growth will stand at 13%. Also, because of the higher risk that isassociated with the new purchase(s), the required return on the common stock isexpected to increase by 2%. QUESTIONS a) Evaluate the proposalsusing the appropriate capital budgeting techniques. Critically discuss theresults and the pros and cons of the applied methodologies. b) Assume that the operatingcash flows associated with Press A are characterised as more risky in contrastto those of Press B. Does this fact have any effect on the appliedmethodologies and subsequently on your recommendations? If yes, how do youpropose to handle the issue? c) Considering that the firmneeds to raise capital for the proposed purchase(s), briefly outline the prosand cons of alternative financial instruments and methods that can be used bythe firm for the financing of the selected purchase(s). Also, criticallydiscuss the capital structure concept. d) Based on the valuation ofPrints Company common share, estimate the effect that the proposed purchase(s)would have on the firm’s shareholders and explain whether the firm shouldundertake the investment or not.

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