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Capital Budgeting Project Solution BALANCE SHEET Cash 2,000,000 Accounts Payable and Accruals 18,000,000 Accounts Receivable 28,000,000 Notes Payable 40,000,000 Inventories 42,000,000 Long-Term Debt...

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Capital Budgeting Project Solution
BALANCE SHEET
    Cash
    2,000,000
    Accounts Payable and Accruals
    18,000,000
    Accounts Receivable
    28,000,000
    Notes Payable
    40,000,000
    Inventories
    42,000,000
    Long-Term Debt
    60,000,000
    
    
    Prefe
ed Stock
    10,000,000
    Net Fixed Assets
    133,000,000
    Common Equity
    77,000,000
    
    
    
    
    Total Assets
    205,000,000
    Total Claims
    205,000,000
· Last year’s sales were $225,000,000.
· The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds ca
y a 10 percent semi-annual coupon, and are cu
ently selling for $874.78.
· You also have 100,000 shares of $100 par, 9% dividend perpetual prefe
ed stock outstanding. The cu
ent market price is $90.00. Any new issues of prefe
ed stock would incur a 3.33% per share flotation cost.
· The company has 10 million shares of common stock outstanding with a cu
ent price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with flotation costs of 15 percent.
· The risk-free rate is cu
ently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22.
· Stockholders require a risk premium of 5 percent above the return on the firms bonds.
· The firm expects to have additional retained earnings of $10 million in the coming year, and expects depreciation expenses of $35 million.
· Your firm does not use notes payable for long-term financing.
· The firm considers its cu
ent market value capital structure to be optimal, and wishes to maintain that structure. (Hint: Examine the market value of the firm’s capital structure, rather than its book value when determining the weights in the WACC calculations.)
· The firm’s management requires a 2% adjustment to the cost of capital for risky projects.
· Your firm’s federal + state marginal tax rate is 40%.
· The firm has the following investment opportunities cu
ently available in addition to the venture that you are proposing:
    Project
    Cost
    IRR
    A
    10,000,000
    20%
    B
    20,000,000
    18%
    C
    15,000,000
    14%
    D
    30,000,000
    12%
    E
    25,000,000
    10%
Your venture would consist of a new product introduction (You should label your venture as Project I, for “introduction”). You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 5-year class. Your venture would require a capital investment of $15,000,000 in equipment, plus $2,000,000 in installation costs. The venture would also require an initial investment in accounts receivable and inventories of $4,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $4,000,000 salvage value.
Your venture, which management considers risky, would increase fixed costs by a constant $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $5,000,000 in year 1, $10,000,000 in year 2, $14,000,000 in year 3, $16,000,000 in year 4, $12,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture.
    Note: Ca
y all final calculations to two decimal places.
Phase 1
1. Find the costs of the individual capital components (12 points):
a.    long-term debt
.    prefe
ed stock
c.    retained earnings (avg. of CAPM, DCF, & bond yield + risk premium approaches)
d.    new common stock
2. Determine the target percentages (weights) for the optimal capital structure. (Ca
y weights to four decimal places. For example: XXXXXXXXXXor 29.73%) (3 points)
3. Compute the retained earnings
eak point. (3 points)
4. Draw the MCC schedule, including depreciation-generated funds in the schedule. (7 points)
Phase 2
5. Compute the Year 0 investment for Project I. (3 points)
6. Compute the annual operating cash flows for years 1-6 of the project. (12 points)
7. Compute the non-operating (end-of-project) cash flows at the end of year 6. (3 points)
8. Draw a timeline that summarizes all of the cash flows for your venture. (3 points)
Note: You may complete #5-8 in an Excel spreadsheet or calculate these manually.
Phase 3
9. Compute the IRR and payback period for Project I. (10 points)
10. Draw the IOS schedule, including Project I along with Projects A-E. (4 points)
11. Determine your firm’s corporate cost of capital. (5 points)
12. Compute the discounted payback and NPV for Project I at the risk-adjusted cost of capital for project I. (10 points)
13. Indicate which projects should be accepted, and why. (10 points)
14. Would your answer be different if the project I was determined to be of average risk? Explain. (5 points)
Phase 4
15. Summarize your findings and recommendations in a
ief (1-2 page) memo to the President of the firm. (10 points)
16. Conclude the project with your reflections on what you have learned from this course and how it has affected your view of your own job and career.
01-set-up-for-capital-budgeting-project-50cjdh2t.docx
Answered Same Day Nov 14, 2021

Solution

Ishmeet Singh answered on Nov 15 2021
144 Votes
Sheet1
        Capital Budgeting
        Long term debt
        No. of bonds    60000
        Nper    15
        Semi annual coupn    10%
        Cu
ent price    874.78
        Calulating the YTM    5.90%
        Annual =    11.80%
        Pre cost of debt =    11.80%
        Tax rate =    40%
        After tax cost of debt =    Pretax cost of debt*(1-tax rate)
        =    7.08%
        Prefe
ed Stock
        No. of stock    100000
        Par value    100
        Dividend    9%
        Cu
ent market price    90
        Flotation cost    3
        Cost of prefe
ed stock =    Dividend
            Cu
ent price - floatation cost
        =    9
            90-3
        =    10.34%
        Cost of retained Earnings
        No. of shares    10000000
        Cu
ent price    14
        Growth rate    10%
        Last dividend    0.8
        Floatation cost    15%
        Risk free rate    6%
        Rate of return    14%
        Beta    1.22
        Using dividend growth model:
        Required rate of return =    D1    +    growth
            Cu
ent price - floatation cost
        =    0.88    +    10%
            11.9
        =    17.39%
        Using CAPM                        WACC vs Returns
                                WACC    Return
        Required rate of return =    Risk free rate + beta *(Expected return - risk free rate)                    8%    106.79
        =    6%+1.22*(14%-6%)                    9%    135
        =    15.76%                    10%    159.17
                                11%    179.32
                                12%    191.4
        Average of CAPM and DCF    16.58%                    13%    201.49
                                14%    203.5
        Calculating the target percentage of capital structure                        MCC Schedule
            No. of shares / bonds    Cu
ent market value    Total value    Weights            No. of shares / bonds    Cu
ent market value    Total value    Weights
        Debt    60000    874.78    52486800    26.05%        Debt    60000    874.78    32237888    16.0%    16
        Prefe
ed Stock    100000    90    9000000    4.47%        Prefe
ed Stock    100000    90    34252756    17.0%    17
        Equity    10000000    14    140000000    69.48%        Equity    10000000    14    134996156    67.0%    67
        Total            201486800    100.00%        Total        In millions    201.49    100.0%
        Calculating Weighted average cost of capital                        Calculating Weighted average cost of capital
        WACC = cost of debt * weight of debt + cost of equity * Weight of equity + Weight of prefe
ed stock * Cost of prefe
ed stock                        WACC = cost of debt * weight of debt + cost of equity * Weight of equity + Weight of prefe
ed stock * Cost of prefe
ed stock
        WACC =    13.83%                    WACC =    14.00%
        Project A
        Year    0    1    2    3    4    5    6
        Initial investment    $10,000,000.00
        Installation cost    $2,000,000.00
        Change in Working capital    $4,000,000.00
        Sale price of the product        $20.00    $20.00    $20.00    $20.00    $20.00    $20.00
        Variable cost of the product        $10.00    $10.00    $10.00    $10.00    $10.00    $10.00
        Sales volume        700000    1000000    650000    700000    650000    550000
        Sales revenue        $14,000,000.00    $20,000,000.00    $13,000,000.00    $14,000,000.00    $13,000,000.00    $11,000,000.00
        Variable Cost        $7,000,000.00    $10,000,000.00    $6,500,000.00    $7,000,000.00    $6,500,000.00    $5,500,000.00
        Fixed cost        $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00
        Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        EBIT        $3,600,000.00    $5,160,000.00    $3,220,000.00    $4,560,000.00    $4,180,000.00    $3,780,000.00
        Tax        $1,440,000.00    $2,064,000.00    $1,288,000.00    $1,824,000.00    $1,672,000.00    $1,512,000.00
        Earnings after tax        $2,160,000.00    $3,096,000.00    $1,932,000.00    $2,736,000.00    $2,508,000.00    $2,268,000.00
        Add: Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        Add: Working capital recovered                            $4,000,000.00
        Salvage value                            $4,000,000.00
        Net operating cash flows    -$16,000,000.00    $4,560,000.00    $6,936,000.00    $4,212,000.00    $4,176,000.00    $3,828,000.00    $10,988,000.00
        Cumulative cash flows    -$16,000,000.00    -$11,440,000.00    -$4,504,000.00    -$292,000.00    $3,884,000.00    $7,712,000.00    $18,700,000.00
        NPV =    $5,759,290.12
        IRR =    25.23%
        Payback period =    4.30
        Profitability index =    1.36
        Project B
        Year    0    1    2    3    4    5    6
        Initial investment    $20,000,000.00
        Installation cost    $2,000,000.00
        Change in Working capital    $4,000,000.00
        Sale price of the product        $20.00    $20.00    $20.00    $20.00    $20.00    $20.00
        Variable cost of the product        $10.00    $10.00    $10.00    $10.00    $10.00    $10.00
        Sales volume        700000    1000000    650000    700000    650000    550000
        Sales revenue        $14,000,000.00    $20,000,000.00    $13,000,000.00    $14,000,000.00    $13,000,000.00    $11,000,000.00
        Variable Cost        $7,000,000.00    $10,000,000.00    $6,500,000.00    $7,000,000.00    $6,500,000.00    $5,500,000.00
        Fixed cost        $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00
        Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        EBIT        $3,600,000.00    $5,160,000.00    $3,220,000.00    $4,560,000.00    $4,180,000.00    $3,780,000.00
        Tax        $1,440,000.00    $2,064,000.00    $1,288,000.00    $1,824,000.00    $1,672,000.00    $1,512,000.00
        Earnings after tax        $2,160,000.00    $3,096,000.00    $1,932,000.00    $2,736,000.00    $2,508,000.00    $2,268,000.00
        Add: Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        Add: Working capital recovered                            $4,000,000.00
        Salvage value                            $4,000,000.00
        Net operating cash flows    -$26,000,000.00    $4,560,000.00    $6,936,000.00    $4,212,000.00    $4,176,000.00    $3,828,000.00    $10,988,000.00
        Cumulative cash flows    -$26,000,000.00    -$21,440,000.00    -$14,504,000.00    -$10,292,000.00    -$6,116,000.00    -$2,288,000.00    $8,700,000.00
        NPV =    -$22,251,388.66
        IRR =    8.13%
        Payback period =    5.21
        Profitability index =    0.14
        Project C
        Year    0    1    2    3    4    5    6
        Initial investment    $15,000,000.00
        Installation cost    $2,000,000.00
        Change in Working capital    $4,000,000.00
        Sale price of the product        $20.00    $20.00    $20.00    $20.00    $20.00    $20.00
        Variable cost of the product        $10.00    $10.00    $10.00    $10.00    $10.00    $10.00
        Sales volume        700000    1000000    650000    700000    650000    550000
        Sales revenue        $14,000,000.00    $20,000,000.00    $13,000,000.00    $14,000,000.00    $13,000,000.00    $11,000,000.00
        Variable Cost        $7,000,000.00    $10,000,000.00    $6,500,000.00    $7,000,000.00    $6,500,000.00    $5,500,000.00
        Fixed cost        $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00
        Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        EBIT        $3,600,000.00    $5,160,000.00    $3,220,000.00    $4,560,000.00    $4,180,000.00    $3,780,000.00
        Tax        $1,440,000.00    $2,064,000.00    $1,288,000.00    $1,824,000.00    $1,672,000.00    $1,512,000.00
        Earnings after tax        $2,160,000.00    $3,096,000.00    $1,932,000.00    $2,736,000.00    $2,508,000.00    $2,268,000.00
        Add: Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        Add: Working capital recovered                            $4,000,000.00
        Salvage value                            $4,000,000.00
        Net operating cash flows    -$21,000,000.00    $4,560,000.00    $6,936,000.00    $4,212,000.00    $4,176,000.00    $3,828,000.00    $10,988,000.00
        Cumulative cash flows    -$21,000,000.00    -$16,440,000.00    -$9,504,000.00    -$5,292,000.00    -$1,116,000.00    $2,712,000.00    $13,700,000.00
        NPV =    $381,528.83
        IRR =    15.03%
        Payback period =    4.75
        Profitability index =    1.02
        Project D
        Year    0    1    2    3    4    5    6
        Initial investment    $20,000,000.00
        Installation cost    $1,000,000.00
        Change in Working capital    $6,000,000.00
        Sale price of the product        $20.00    $20.00    $20.00    $20.00    $20.00    $20.00
        Variable cost of the product        $10.00    $10.00    $10.00    $10.00    $10.00    $10.00
        Sales volume        700000    1000000    650000    700000    650000    550000
        Sales revenue        $14,000,000.00    $20,000,000.00    $13,000,000.00    $14,000,000.00    $13,000,000.00    $11,000,000.00
        Variable Cost        $7,000,000.00    $10,000,000.00    $6,500,000.00    $7,000,000.00    $6,500,000.00    $5,500,000.00
        Fixed cost        $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00    $1,000,000.00
        Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        EBIT        $3,600,000.00    $5,160,000.00    $3,220,000.00    $4,560,000.00    $4,180,000.00    $3,780,000.00
        Tax        $1,440,000.00    $2,064,000.00    $1,288,000.00    $1,824,000.00    $1,672,000.00    $1,512,000.00
        Earnings after tax        $2,160,000.00    $3,096,000.00    $1,932,000.00    $2,736,000.00    $2,508,000.00    $2,268,000.00
        Add: Depreciation        $2,400,000.00    $3,840,000.00    $2,280,000.00    $1,440,000.00    $1,320,000.00    $720,000.00
        Add: Working capital recovered                            $6,000,000.00
        Salvage value                            $4,000,000.00
        Net operating cash...
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