• Suppose DuPont is considering an investment that would extend the life of one
ID: 2726662 • Letter: #
Question
• Suppose DuPont is considering an investment that would extend the life of one of its chemical facilities for 4 years
• The project would require upfront costs of $6.67 million plus a $24 million investment in equipment • The equipment will be obsolete in 4 years and will be depreciated via straight-line over that period
• During the next four years, however, DuPont expects annual sales of $60 million per year from this facility
• Material costs and operating expenses are expected to total $25 million and $9 million, respectively, per year
• DuPont expects no net working capital requirements for the project, and it pays a tax rate of 35%
• Dupont's 10-year, 7% annual coupon, $1,000 PAR bonds are currently trading for $1,275.54
• Assume DuPont’s class A preferred stock has a price of $66.67 and an annual dividend of $3.50.
• Assume the equity beta of DuPont is 1.37, the yield on ten-year Treasury notes is 3%, and you estimate the market risk premium to be 6%.
• The current market values of DuPont’s common stock, preferred stock, and debt are $30,860 million, $187 million, and $9543 million, respectively
Dupont's project and firm WACC are equal. Should Dupont accept this project?
Explanation / Answer
$ ( in millions)
Step:1 Initial cash flows Cost of asset 24 upfront costs 6.67 Total 30.67 Step:2 In-between cash flows Year 1 2 3 4 sales 60 60 60 60 Less cost of material 25 25 25 25 Operating expenses 9 9 9 9 Depreciation 6 6 6 6 PBT 20 20 20 20 Tax@035% 7 7 7 7 PAT 13 13 13 13 Add;Depreciation 6 6 6 6 FCF 19 19 19 19 Step:3 Terminal cash flows It is assumed that upfront cost paid is received at the end of the 4th year upfront costs received 6.67 Step:4 Analysis of cash flows Year Cash flows PVF@6.5% 0 -30.67 1 -30.67 1 19 0.938967 17.84038 2 19 0.881659 16.75153 3 19 0.827849 15.72913 4 19 0.777323 14.76914 4 6.67 0.777323 5.184745 NPV 39.60492 Since NPV is positive , Project should be accepted Working note : Computation of WACC Weights Market value of common stock 30860 0.760286 7.11% 0.054056 Market value preffered stock 187 0.004607 5.25% 0.000242 Market value of debt 9543 0.235107 4.5500% 0.010697 40590 WACC 6.50% Ke = Rf +beta ( Rm Rf) 3%+1.37(6%-3%) 7.11%Related Questions
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