Create an assessment in which you address the following problems/questions: Asse
ID: 2792412 • Letter: C
Question
Create an assessment in which you address the following problems/questions:
Assess the relevant cash flows used to form a capital budgeting decision model. For this assignment, focus upon an expansionary problem.
Evaluate the cost of capital (WACC) for use in a capital budgeting decision model. Make sure to define each component of the formula. Explain how the resulting cost of capital (WACC) is used within a capital budgeting model. How can the Capital Asset Pricing Model contribute to this analysis? Explain.
Weigh each of the following decision metrics that can be used within a capital budgeting decision model: net present value, internal rate of return, modified internal rate of return, payback period, and discounted payback period. Explain how each metric is formed and discuss the critical value of each in forming conclusions within a capital budgeting decision model. Discuss which method has the strongest basis for being used and under which conditions each might be the preferred method.
Develop a capital budgeting decision model that displays cash flows, cost of capital, and decision metrics (i.e., npv, irr, mirr, payback, and discounted payback). Then, form a conclusion based upon the analysis. What are some problems with the payback period? Is NPV better than IRR? Begin with the example problem on pages 405 and 406 of the textbook, Table 12.1. Modify the problem in the following manner, and then develop the analysis within an Excel spreadsheet.
Assume the units sold are 2,700,000 in year 2013, and they grow each subsequent year at 5%.
Assume each unit will sell for $2.10.
Assume the variable cost of producing each unit is 1.10.
Assume straight-line depreciation.
The cost of capital is calculated based upon funding from retained earnings and from debt. The company is assumed to fund itself with 50% debt and 50% retained earnings. The cost of debt capital, rD, is 7%. The cost of capital from retained earnings, rS, is based upon the capital asset pricing model. The risk free rate in the market is 5% and the difference between the expected return on the market and the risk free rate is 5%. The beta for the company is 2.0. The tax rate is assumed to be 40%.
Complete a sensitivity analysis in which you reevaluate the model considering the selling price per unit is 1.90, 2.00, 2.10, 2.20, and 2.30. Present and comment on the results.
Assume all other assumptions as given.
Explanation / Answer
Calculation of WACC = weight of debt*Cost of Debt + Weight of Equity * Cost of Equity*
= 0.5 * 4.2% + 0.5*15% = 9.6%
(Calculation of Cost of Debt = Rd(1-tax) = 7%(1-04) = 4.2%
Calculation of Cost of equity = Rf + Beta (Rm - Rf) = 5% + 2*5% = 15%)
Calculation of Contribution
Sales = $2.10
Less :Variable Cost = $1.1
Contribution = $1.0
(* it is assumed that there is no fixed cost and no assets is purchased for this project so no, deprication is charged and life of project is 5 Yrs )
year Sales Unit Contribution Tax Profit After Tax PVAF @9.6% Disc. Cashflow
1 27,00,000 27,00,000 1080000 16,20,000 0.912 14,77,440
2 28,35,000 28,35,000 1134000 17,01,000 0.832 14,15,232
3 29,76,750 29,76,750 1190700 17,86,050 0.760 13,57,398
4 31,25,588 (appx.) 31,25,588 1250235 18,75,353 0.693 12,99,620
5 32,81,867 32,81,867 1312747 19,69,120 0.632 1244484
NPV 67,94,174
If we Assume A Fixed Assets required @ cost of 50,00,000 And Life of project is 5 Yr Then Calculation of NPV
Year Contribution Deprication profit Before Tax Tax Net Cash Flow PVAF Disc. Cashflow
0 (50,00,000) 1 (50,00,000)
1 27,00,000 10,00.000 17,00,000 6,80,000 20,20,000 0.912 18,42,240
2 28,35,000 10,00,000 18,35,000 7,34,000 21,01,000 0.832 17,48,032
3 29,76,750 10,00,000 19,76,750 7,90,700 21,86,050 0.760 16,61,398
4 31,25,588 10,00,000 21,25,588 8,50,235.2 22,75,353 0.693 15,76,820
5 32,81,867 10,00,000 22,81,867 9,12,747 23,69,120 0.632 14,97,284
Net Present Value 33,25,774
If Discounted Rated is taken at 35%
Year Net Cash Flow Pvaf Disc. Cashflow
0 (50.00.000) 1 -50,00,000
1 20,20,000 0.741 14,96,820
2 21,01,000 0.549 11,53,449
3 21,86,050 0.406 887536
4 22,75,353 0.301 684881
5 23,69,120 0.223 528314
Net Present Value ( 249000)
Calculation of IRR
Lower Rate + ( Higest NPV/(Higest NPV - Lowest NPV))*Difference In Rates
= 9.6% + (33,25,774/3574775)*25.4%
= 9.6 + 23.631 = 33.23 %
Calculation Of PayBack Period (
Year Net Present Cash Flow Cumulative Cash Flow
1 20,20,000 20,20,000
2 21,01,000 41,21,000
3 21,86,050 63,07,050
4 22,75,353 85,82,403
5 23,69,120 10,951,523
Pay Back Period = 2 Yrs + 8,79,000/21,86,050 = 2.40 Yrs
Sestivity Analysis
If Price is 1.90 = (1.9-2.1)/2.1 *100 = - 9.52%
iF Price is 2.0 = (2-2.1)/2.1*100 = -4.76%
If Price Is 2.1 =( 2.1-2.1)/2.1 *100 = 0%
If price Is 2.2 = (2.2 - 2.1)/2.1*100 = 4.76%
If Price Is 2.3 = (2.3-2.1)/2.1*100 = 9.52%
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