It is publically traded. The current stock price is 3 dollars per share and ther
ID: 2796819 • Letter: I
Question
It is publically traded. The current stock price is 3 dollars per share and there are 20 million shares outstanding. the present value of the company's debt is 40 million. the company has a bond issue outstanding will 6 years to maturity. the face balue is $1,000 the coupon rate is 8% paid annual and the bond is currently selling for $1,020. the company's corporate tax rate is 35 % and their beta is 1.41. The current risk free rate is 5% and the historic market return is 12%.
1. What is the WACC?
2. What is the project NPV?
3. What is the project IRR?
Quiz Ray's Racks, a company that develops and manufactures bike racks and locks, has developed a new, highly simplified bike lock. It can go into production for an initial investment in equipment of $5.7 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $671,000. The firm estimates production costs of $1.80 per lock and believes that the locks can be sold for $8 each. The firm believes that working capital (primarily for spare parts) must be maintained at a level of 10% of next year's forecast sales. The project will come to an end in 6 years, when the lock becomes technologically obsolete. The firm's tax bracket is 35%. This project is considered to be an average risk project for Ray's Racks. Sales forecasts (number of locks sold) are given in the following table. 6 Thereafter 0 Year 0 2 4 Sales (locks) 0 400,000 500,000 700,000 700,000 500,000 300,000Explanation / Answer
The stock price is $3 and 20 million shares thus total equity = 3*20 = 60 million
and the book value of 40 million
Thus total =60+40 = 100 million
Weight of debt = 40/100 = 40%
and weight of equity = 60 /100 = 60%
Cost of equity = Ke = rf+beta*(rm-rf)
=0.05+1.41*(0.12-0.05)
=0.05+0.0987
=0.1487
=14.87%
Cost of debt = debt*(1-tax)
=8*(1-0.35)
=5.2%
Answer 1.
WACC = We*Ke + Wd*Kd
= 0.6*0.1487 + 0.4*0.052
=0.08922 + 0.0208
=0.11002
=11.002%
Answer 2.
FCinv = 5700,000
WCinv = 10% of next year sales 400,000*8 = 0.1*3200,000 = 320,000
Initial outlay = FCinv+WCinv
=5700,000+320,000 = 6020,000
Depreciation at SLM for 6 years at salvage of 671000 = 5700,000-671000 / 6 = 838166.6667
Terminal year cashflow = Salvage value+WCinv - tax*(salvage-book value)
=671000+320000-0.35*(671000-0)
=991000-234850
=756150 (and this will be added to final year CF)
After tax cashflow = (sales-cost-depreciation)*(1-tax) + Depreciation
Answer 2. and 3.
Year
Units
Revenues = Units*8
Cost = Units*1.8
Depreciation
After Tax Cashflow = (sales-cost-depreciation)*(1-tax) + Depreciation
0
-6020000
1
400000
3200000
720000
838167
1905358
2
500000
4000000
900000
838167
2308358
3
700000
5600000
1260000
838167
3114358
4
700000
5600000
1260000
838167
3114358
5
500000
4000000
900000
838167
2308358
6
300000
2400000
540000
838167
2258508
NPV at WACC of 11.002%
$4,031,942.22
IRR
32.995%
NPV of the project is $4031,942.22
IRR of the project is 32.995%
Year
Units
Revenues = Units*8
Cost = Units*1.8
Depreciation
After Tax Cashflow = (sales-cost-depreciation)*(1-tax) + Depreciation
0
-6020000
1
400000
3200000
720000
838167
1905358
2
500000
4000000
900000
838167
2308358
3
700000
5600000
1260000
838167
3114358
4
700000
5600000
1260000
838167
3114358
5
500000
4000000
900000
838167
2308358
6
300000
2400000
540000
838167
2258508
NPV at WACC of 11.002%
$4,031,942.22
IRR
32.995%
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