Name problem (30 points) Problem (30 points) WACC, capital budgeting, and econom

Question

Name problem (30 points) Problem (30 points) WACC, capital budgeting, and economic break-even (30 points) Your boss has given you the following project to analyze. The project involves converting an old warehouse your company owns into a new production facility. . The warehouse could be sold today for $500,000 before taxes. It currently has a book value of zero. The project would require $2,200,000 in renovations and equipment. This investment will be depreciated using the straight-line method to a salvage value of $200,000 over 5 years. At that point, after the project is complete, the warehouse and equipment could be sold for $150,000 before taxes. Be sure to calculate the tax effects, if any, of these items. The project would last for 5 years. Each year, you expect to sell 25,000 units at $70 each. Variable costs per unit are $30. Yearly fixed costs to maintain the equipment will be $50,000. . . The project will require transferring a manager who currently works for the company from another factory to the warehouse. Her yearly salary is $75,000. The project will also require hiring a new accountant at a cost of $60,000 per year. . The project would need levels of inventory of $100,000 immediately, $150,000 in one year, and $200,000 in two years. After that, inventory levels will remain constant, until they are completely recovered at cost at the end of the project. Your company's margin tax rate is 35% Your company has issued S100 million in bonds. They have a face value of S100, pay a 5% annual coupon, were issued at par, mature in 8 years, and currently trade at $880.57 . Your company has 10 million shares outstanding. They currently trade at $35.22 per share. Your company's beta is 1.5. The current risk-free rate is 3% and the expected market premium is 8%.

Explanation / Answer

All Amounts in $ Weighted Average Cost of Capital, which is used as the discount rate Particulars of Capital Market Rate of Post Tax Weighted Value Capital Capital Capital Rate Value Bonds 880570000 5% 3.2500% 28618525 Equity Share Capital 352200000 7.5% 7.5% 26415000 Total 1232770000 55033525 Thus, the Weighted Average Cost of Capital or WACC is equal to 4.46% For the calculation of the Net Present Value, we need to first work out the Cash Inflows and Outflows Cash Outflows, net of tax at Year T = 0 Sale of Old Warehouse net of tax 325000 Increase in Working Capital -100000 Renovations and Equipment -2200000 Total Cash Outflows -1975000 Besides this, increase in Working Capital in T = 1 is -150,000 and T = 2 is $ 200,000 Cash Inflows per year Net Income for 25,000 units before tax 950000 50,000 Fixed Costs deducted from this value Depreciation on Equipment 400000 (2,200,000 - 200,000) / 5 Manager Salary 75000 Accountant Salary 60000 415000 Tax Impact @ 35% 145250 Operating Income post tax 269750 Add : Depreciation 400000 Operating Cash Flows post tax 669750 Sale of warehouse and equipment at T = 5 150000 Based on the information given, the Net Present Value of the project works out to $ 479,452.80 The breakeven point is a quantity where Sales Revenues = Costs Assuming the quantity to breakeven as X 70X - 30X = 50,000 + 75,000 + 400,000 + 60,000 Thus 40X = 585,000 or X = 14625 units

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