A firm is considering undertaking a capital investment project. The firm is plan
ID: 2755137 • Letter: A
Question
A firm is considering undertaking a capital investment project. The firm is planning on producing a new line of oversize tennis rackets. The additional equipment needed to produce the new rackets would cost $402,215 initially. This amount will be depreciated straight line to a zero salvage value over a 5 year life. The company has already spent $145,000 on an extensive marketing survey that yielded encouraging results for their project. Also, if the firm decides to make the new rackets they will be unable to sell $192,000 (after tax value) of equipment they had planned on selling. The project will require an additional $34,000 in working capital at the start of the project. The increased working capital will not be needed after year 5.
The project’s marginal operating revenues and expenses before taxes are given in the following table (the project has a five year life):
(Marginal)
Year 1
Year 2
Year 3
Year 4
Year 5
Sales Revenue
$399,412
$405,615
$422,000
$397,555
$289,410
Variable Costs
20% of revenue
20% of revenue
20% of revenue
20% of revenue
20% of revenue
Fixed Costs
$89,500
$89,500
$89,500
$89,500
$89,500
Depreciation
?
?
?
?
?
All revenues and expenses are on a cash basis. The firm has a marginal tax rate of 34% and an average tax rate of 25%. The required return on equity is 10.250%, and the firm’s pre-tax cost of debt is 4.167%. The firm employs a 46% debt to capital ratio. The firm considers this project to be about the same level of risk as the typical project for the firm.
Watch your rounding, excessive rounding will result in incorrect answers. Round your final answers to two decimal places but do not round any intermediate calculations or variables to less than 4 decimal places. You will not get credit if you do not show your work with the appropriate formulas.
SHOW YOUR WORK PLEASE!!!!
A) What is the firm’s WACC? (Show your work.) (1 point)
B) What is the project’s NPV? (For full credit you must show your work by providing a timeline of the initial cost and the calculation for each year’s Cash Flow from Assets, and also show the NPV equation and the solution.) (4 points)
C) What is the project’s IRR? (Show the IRR equation and provide the calculator solution.) (1 point)
D) What is the project’s payback? (1 point, show your work.)
E) Should the firm take the project? Indicate why. If they do by how much should shareholder wealth change? (1 point)
(Marginal)
Year 1
Year 2
Year 3
Year 4
Year 5
Sales Revenue
$399,412
$405,615
$422,000
$397,555
$289,410
Variable Costs
20% of revenue
20% of revenue
20% of revenue
20% of revenue
20% of revenue
Fixed Costs
$89,500
$89,500
$89,500
$89,500
$89,500
Depreciation
?
?
?
?
?
Explanation / Answer
IRR of the project = 2.1%
The project should not be accepted as the NPV is negative .
Firm's WACC Return Weights WACC Equity 10.25% 54% 5.54% After tax cost of debt-(4.167*(1-.34)) 2.75% 46% 1.27% 100% 6.80% Equipment cost 402,215 usefule life 5 Depreciation 80443 Working capital 34000 Cash outflow 436,215 Note: 145,000 spent on extensive marketing survey is a sunk cost hence to be ignored (Marginal) Year0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash outflow -436,215 Sales Revenue $399,412 $405,615 $422,000 $397,555 $289,410 Variable Costs $79,882.40 $81,123.00 $84,400.00 $79,511.00 $57,882.00 Gross profit $319,529.60 $324,492.00 $337,600.00 $318,044.00 $231,528.00 Fixed Costs $89,500 $89,500 $89,500 $89,500 $89,500 Depreciation 80443 80443 80443 80443 80443 Profit before Tax $9,057 $9,057 $9,057 $9,057 $9,057 Tax 34% $3,079.38 $3,079.38 $3,079.38 $3,079.38 $3,079.38 Profit after tax $5,977.62 $5,977.62 $5,977.62 $5,977.62 $5,977.62 ADD: Depreciation 80443 80443 80443 80443 80443 Cashflow $86,420.62 $86,420.62 $86,420.62 $86,420.62 $86,420.62 recovery of working capital 34000 net cashflow -436,215 $86,420.62 $86,420.62 $86,420.62 $86,420.62 $120,420.62 PV interest factor(6.8%) 1 0.936 0.877 0.821 0.769 0.72 PV of cashflow (436,215) 80,890 75,791 70,951 66,457 86,703 NPV (55,423) Cummulative cashflow -436,215 -349,794.38 -263,373.76 -176,953.14 -90,532.52 29,888.10 Payback period = 4+(90532/120420) 4.75 YearsRelated Questions
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