Please see attached fileCapital Budgeting Project Solution BALANCE SHEET Cash 2,000,000 Accounts...

Question

Please see attached fileCapital 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 	 	 	Preferred 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 carry a 10 percent semi-annual coupon, and are currently selling for $874.78. · You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a 3.33% per share flotation cost. · The company has 10 million shares of common stock outstanding with a current 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 currently 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 current 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 currently 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: Carry all final calculations to two decimal places. Phase 1 1. Find the costs of the individual capital components (12 points): a.	long-term debt b.	preferred 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. (Carry weights to four decimal places. For example: 0.2973 or 29.73%) (3 points) 3. Compute the retained earnings break 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 brief (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.

Ishmeet Singh · Accepted Answer

Sheet1
		Capital Budgeting 
		Long term debt
		No. of bonds	60000
		Nper	15
		Semi annual coupn	10%
		Current 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%
		Preferred Stock
		No. of stock	100000
		Par value	100
		Dividend	9%
		Current market price	90
		Flotation cost	3
		Cost of preferred stock =	Dividend
			Current price - floatation cost
		=	9
			90-3
		=	10.34%
		Cost of retained Earnings
		No. of shares	10000000
		Current 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
			Current 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	Current market value	Total value	Weights			No. of shares / bonds	Current market value	Total value	Weights
		Debt	60000	874.78	52486800	26.05%		Debt	60000	874.78	32237888	16.0%	16
		Preferred Stock	100000	90	9000000	4.47%		Preferred 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 preferred stock * Cost of preferred stock						WACC = cost of debt * weight of debt + cost of equity * Weight of equity + Weight of preferred stock * Cost of preferred 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 flows	-$27,000,000.00	$4,560,000.

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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