Balance Sheet Data Cash 3,000,000 Accounts Payable and Accruals 14,000,000 Accou
ID: 2499924 • Letter: B
Question
Balance Sheet Data
Cash
3,000,000
Accounts Payable and Accruals
14,000,000
Accounts Receivable
24,000,000
Notes Payable
29,356,200
Inventories
55,000,000
Long-Term Debt (Bonds)
52,243,800
Preferred Stock
9,400,000
Net Fixed Assets
173,000,000
Common Stock (Equity)
150,000,000
Total Assets
255,000,000
Total Liabilities & Owners Eq.
255,000,000
Last year’s sales were $210,000,000. The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 9 percent semi-annual coupon, and are currently selling for $870.73. You also have 100,000 shares of perpetual preferred stock outstanding, which pays a dividend of $7.80 per share. The current market price is $94.00. The company has 10 million shares of common stock outstanding with a current price of $15.00 per share. The stock exhibits a constant growth rate of 8 percent. The last dividend (D0) was $.90.
Your firm does not use notes payable for long-term financing. The firm’s target capital structure is 25% debt, 5% preferred stock, and 70% common equity. The firm does not plan to issue new common stock. Your firm’s federal + state marginal tax rate is 38%.
The firm has the following investment opportunities currently available in addition to the venture that you are proposing:
Project NPV IRR
A 5,000,000 20%
B 4,000,000 10%
C 3,500,000 15%
D 3,000,000 11%
E 2,000,000 8%
All projects, including Project I, are assumed to be of average risk. Your venture would consist of a new product introduction (You should label your venture as Project I, for “introduction”). You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 5-year class. The resulting MACRS depreciation percentages for years 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and 6%. Your venture would require a capital investment of $17,000,000 in equipment, plus $1,000,000 in installation costs.
The venture would also result in an increase in accounts receivable and inventories of $3,000,000. This means there is a change in NWC (cash outflow) at the start of the project. The NWC ($ 3,000,000) will be released as a cash inflow in Year 6.
At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $5,000,000 salvage value. Your venture would incur fixed costs of $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $6,000,000 in year 1, $14,000,000 in year 2, $15,000,000 in year 3, $16,000,000 in year 4, $11,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.
1. Find the costs of the individual capital components a. long-term debt b. preferred stock c. Common Stock (Equity) (use DCF approach)
2. Determine the weighted average cost of capital.
3. Compute the Year 0 investment for Project I.
4. Compute the annual operating cash flows for years 1-6 of the project.
5. Compute the non-operating (terminal Salvage and change in NWC) cash flow at the end of year 6.
6. Draw a timeline that summarizes all of the cash flows for your venture.
7. Compute the IRR, payback, discounted payback, and NPV for Project I.
8. Prepare a report for the firm’s CEO indicating which projects should be accepted and why.
Cash
3,000,000
Accounts Payable and Accruals
14,000,000
Accounts Receivable
24,000,000
Notes Payable
29,356,200
Inventories
55,000,000
Long-Term Debt (Bonds)
52,243,800
Preferred Stock
9,400,000
Net Fixed Assets
173,000,000
Common Stock (Equity)
150,000,000
Total Assets
255,000,000
Total Liabilities & Owners Eq.
255,000,000
Explanation / Answer
1.
Cost of Debt =[ interest *(1- Tax) + (R.V.-M.P./n) ] / (R.V. + M.P./2)
Cost of bond = [45*(1- 0.38) + (1000-870.73/30)] / (1000+870.73/2)
= 3.4%
Dividend = $7.80 per share
current market price = $94.00
Cost of preferred stock = 7.8/94
= 8.30 %
current price = $15.00 per share
growth rate = 8 percent
dividend (D0) = $.90
Cost of equity = [ D0(1 + g) / P0 ] + g
= 0.90 (1+0.08) / 15 + 0.08
= 14.48%
Bonds= 60,000,0000
Preferred =100,000,000
Equity = 150,000,000
Total capital = 310 million
2.
WACC = weight of debt * Cost of Debt + weight of preferred * Cost of preferred share +weight of equity * Cost of equity
= 3.4% * (60 Million/310) + 8.3% *(100/310) + 14.48% * (150/310)
= 10.34%
Target capital structure is 25% debt, 5% preferred stock, and 70% common equity.
= 3.4% * 0.25 + 8.3% * 0.05 + 14.48% * .70
= 11.4%
3.
Year 0 investment for Project I.
capital investment
equipment = $17,000,000
installation costs = $1,000,000
Total investment (y=0) = $ 18,000,000
4.
Particulars
Y=1
Y=2
Y=3
Y=4
Y=5
Y=6
revenues generated by the project
$6,000,000
$14,000,000
$15,000,000
$16,000,000
$11,000,000
$8,000,000
Less- variable cost
$1,800,000
$4,200,000
$4,500,000
$4,800,000
$3,300,000
$2,400,000
Less- fixed cost
1000000
1000000
1000000
1000000
1000000
1000000
Add- tax savings due to depreciation
136800
1751040
706982
361667
291753
141633
Less- working capital increment
3000000
-
-
-
-
(3000000)
Net annual cash flow
$6,336,800
$10,551,040
$10,206,982
$10,561,667
$6,991,753
$1,741,633
5. non-operating (terminal Salvage and change in NWC) cash flow at the end of year 6. =
salvage value = $5,000,000
Value at end = 9079276
Loss on sale = 4079276
Tax savings = 1550125
Net salvage value = 5000000 - 1550125
= = 3449875
Particulars
Y=1
Y=2
Y=3
Y=4
Y=5
Y=6
revenues generated by the project
$6,000,000
$14,000,000
$15,000,000
$16,000,000
$11,000,000
$8,000,000
Less- variable cost
$1,800,000
$4,200,000
$4,500,000
$4,800,000
$3,300,000
$2,400,000
Less- fixed cost
1000000
1000000
1000000
1000000
1000000
1000000
Add- tax savings due to depreciation
136800
1751040
706982
361667
291753
141633
Less- working capital increment
3000000
-
-
-
-
(3000000)
Net annual cash flow
$6,336,800
$10,551,040
$10,206,982
$10,561,667
$6,991,753
$1,741,633
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