Cash 2,000,000 Accounts Payable and Accruals 18,000,000 Accounts Receivable 28,000,000 Notes Payable 40,000,000 Inventories 42,000,000 Long-Term Debt 60,000,000 Preferred Stock 10,000,000 Net Fixed Assets 133,000,000 Common Equity 77,000,000 Total Assets 205,000,000 Total Claims 205,000,000 Market Values of Capital • The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent semiannual coupon and are currently selling for $874.78. You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost. The company has 5 million shares of common stock outstanding with a current price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with flotation costs, including market pressure, of 15 percent. The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22. Your firm does not use notes payable for long-term financing. Your firm’s federal + state marginal tax rate is 40%. Requirements 1. Find the costs of the individual capital components: a. long-term debt (before tax and after tax) b. preferred stock-ings (avg. of CAPM and DCF)- Determine the target percentages for the optimal capital structure, and then compute the WACC. (Carry weights to four decimal places. For example: 0.2973 or 29.73%) Create a valuation spreadsheet for each of the projects mentioned above. Evaluate each project according to the following valuation methods: a. Net Present Value of Discounted Cash Flow b. Internal Rate of Return c. Payback Period d. Profitability Index Identify the sensitivity of the projects related to a 10% reduction in price and a 10% reduction in sales volume. . Provide a synopsis evaluation of each project and provide a recommendation of which project management will accept for its capital expenditures budget for the upcoming year. Project A: This project requires an initial investment of $20,000,000 in equipment which will cost an additional $3,000,000 to install. The firm will use the attached MACRS depreciation schedule to expense this equipment. Once the equipment is installed, the company will need to increase raw goods inventory by $5,000,000, but it will also see an increase in accounts payable for $1,500,000. With this investment, the project will last 6 years at which time the market value for the equipment will be $1,000,000. Project B: This project requires an initial investment of $20,000,000 in equipment which will require an additional expense of $1,000,000 to install in the current facility. Consistent with other projects, the equipment will be depreciated using the MACRS Investment Class schedule. Once installed, the firm will need to increase inventory by $6,000,000. The project will last 6 years, but at the end of that period, the equipment will have no salvage value. Project C: The project is outside of the normal products sold by the firm. The project is a reconsideration of a project proposed two years ago by a former manager. At that time a marketing study costing $200,000 was done; however, the project was not undertaken. Now the firm needs to consider if this project is worth the firm’s capital investment dollars. This project would require investment in equipment of $20,000,000 with an additional cost of $5,000,000 in installation fees. The project will be considered under a 6-year project cycle but would be depreciated
BALANCE SHEET
Cash |
2,000,000 |
Accounts Payable and Accruals |
18,000,000 |
Accounts Receivable |
28,000,000
|
Notes Payable |
40,000,000 |
Inventories |
42,000,000 |
Long-Term Debt |
60,000,000 |
|
|
|
10,000,000 |
Net Fixed Assets |
133,000,000 |
Common Equity |
77,000,000 |
|
|
|
|
Total Assets |
205,000,000 |
Total Claims |
205,000,000 |
Market Values of Capital
• The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent semiannual coupon and are currently selling for $874.78.
- You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost.
- The company has 5 million shares of common stock outstanding with a current price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with flotation costs, including market pressure, of 15 percent.
- The risk-free rate is currently 6 percent, and the
rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22. - Your firm does not use notes payable for long-term financing.
- Your firm’s federal + state marginal tax rate is 40%.
Requirements
1. Find the costs of the individual capital components:
a. long-term debt (before tax and after tax)
b. preferred stock-ings (avg. of
- Determine the target percentages for the optimal capital structure, and then compute the WACC. (Carry weights to four decimal places. For example: 0.2973 or 29.73%)
- Create a valuation spreadsheet for each of the projects mentioned above. Evaluate each project according to the following valuation methods:
a.Net Present Value of Discounted Cash Flow
b.Internal Rate of Return
c. Payback Period
d. Profitability Index - Identify the sensitivity of the projects related to a 10% reduction in price and a 10% reduction in sales volume.
.
- Provide a synopsis evaluation of each project and provide a recommendation of which project management will accept for its capital expenditures budget for the upcoming year.
Project A:
This project requires an initial investment of $20,000,000 in equipment which will cost an additional $3,000,000 to install. The firm will use the attached MACRS depreciation schedule to expense this equipment. Once the equipment is installed, the company will need to increase raw goods inventory by $5,000,000, but it will also see an increase in accounts payable for $1,500,000. With this investment, the project will last 6 years at which time the market value for the equipment will be $1,000,000.
Project B:
This project requires an initial investment of $20,000,000 in equipment which will require an additional expense of $1,000,000 to install in the current facility. Consistent with other projects, the equipment will be
Project C:
The project is outside of the normal products sold by the firm. The project is a reconsideration of a project proposed two years ago by a former manager. At that time a marketing study costing $200,000 was done; however, the project was not undertaken. Now the firm needs to consider if this project is worth the firm’s capital investment dollars. This project would require investment in equipment of $20,000,000 with an additional cost of $5,000,000 in installation fees. The project will be considered under a 6-year project cycle but would be depreciated under the 5-year MACRS schedule. At the end of the project, management estimates that the equipment could be sold at a market value of $5,000,000. This project also creates a need to increase raw goods inventory by $6,000,000.
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