Question

Please answer this question using one spreadsheet, with a tab for each of the questions listed in red. Please show your work and label appropriately (e.g. beta 1.25 etc.)


Part II: Whitestone is interviewing bright, eager MBA students for positions in the firm. Here are a few of their interview questions. Do you know the answers?

1.     Boutique Booksellers is considering expanding each of its five shops to include a gourmet coffee shop. It has identified Javabean, a firm that is solely in the gourmet coffee shop business, as a possible acquisition. Both firms have a very small amount of debt and Boutique Booksellers does not anticipate taking on more debt in the acquisition.

Javabean’s beta is 1.25 and Boutique’s beta is 1.60. The risk-free rate is 3% and the risk premium is 7%. If Boutique decides to make the acquisition, 15% of its funds would be invested in gourmet coffee operations and 85% would remain invested in its basic bookstore operation.

     (Answer this question in 1st tab spreadsheet )
a.     If Boutique expects the gourmet coffee shop to generate additional cash flows of $50,000 a year in perpetuity, what is the maximum amount it should be willing to pay for Javabean?

b.     Suppose Boutique does make the acquisition. Is it appropriate for Boutique to use the overall, or weighted, cost of capital to evaluate new projects that expand the gourmet coffee shop division? Why or why not?

2.     Assume your firm will consist of just one machine. The machine costs $126,000 and has a physical life of 10 years. Tax laws require that the machine be depreciated over 7 years, using straight-line depreciation. The machine produces $50,000 a year in sales and requires cash expenses of $15,000 a year. All sales are cash sales. You firm’s marginal tax rate is 40%.
                   
(Answer this question in 2nd tab spreadsheet )
Your overall cost of capital is 14% a year. Your firm has $80,000 of debt at an interest rate of 10% a year. Your first interest payment is due in year 1. Your last interest payment and the principal on the debt are due in year 10. What is the NPV of the project?

3.     The following information was collected from Cisco Corporation’s July 2007 annual report:

Sales                              $34.92 billion
Net income                         $7.33 billion
          Interest expense                    $0.38 billion
          Net debt issued                         $0
          Cash flow from operating activities          $10.10 billion
          Cash flow from investing activities          -$8.34 billion
          Cash flow from financing activities          -$1.33 billion

(Answer this question in 3rd tab spreadsheet)

Cisco’s closing price on July 28,2007 was $28.97 and there were 6.07 billion shares outstanding. What was Cisco’s Price/Free Cash Flow Ratio?