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In: Finance

1. Taco Bell is evaluating a project that costs $10,000,000 in a project. The project is...

1. Taco Bell is evaluating a project that costs $10,000,000 in a project. The project is to be financed by drawing down 6 million of the firm’s cash reserves, which is earning a risk-free return of 4%, and remaining 4 million will be raised by issuing new debt, requiring 5%. The firm’s current income statement is the following:
EBIT
6,500,000
Interest Expense (minus)
400,000
Interest Income (add)
240,000
EBT
6,340,000
Taxes (21%)
1,331,400
Net Income
5,008,600
The firm has 2 million shares outstanding. The firm has a cost of equity of 10%, and a WACC of 8%.
The project is expected to generate 650,000 in EBIT forever, and does not have any associated depreciation expenses, or NWC needs.
A. What is the Net Present Value of the Project?
B. Calculate the EPS of the firm, the EPS of the Project, and Firm + Project EPS. What impact will it have on the EPS of the firm? Is the project accretive or dilutive?
C. What is the Economic Value Added of the project?
D. Given the information in A-C, should we accept or reject the project?
E. Using the same information in question 1, lets assume that Taco Bell funds the full 10,000,000 by issuing equity. If Taco Bell’s current stock price is $18.00 a share, what impact will it have on the EPS of the firm? What is the new EPS under this scenario? Is the project accretive or dilutive?


Solutions

Expert Solution

A.

Amount Formlua
EBIT of project 650000
Interest Expense 200000
Income let go due to using Cash Reserve 24000
Project EBT 426000
Tax 89460
Project Net Income 336540
Required Rate of the project (WACC) 0.00158 =((1-tax rate)* Cost of debt* Portion of project fiannced by debt)
PV of the perpetual Cash Flow 21,30,00,000 =Net Income/Wacc

B.

a Project Net Income 336540
b Total Income of Firm 5008600
c Total Share Outstanding 2000000
d Total Income of Firm + Project 5345140 a+b
e EPS of firm 2.5043 b/c
f EPS of the project 0.16827 a/c
g EPS of Project + Firm 2.67257 d/c

Project is accretive as EPS is increased when firms took the project. Evident by above table g>e.

c. NOPAT in the formula would be equal to Net Income as we have not used any depreciation in the formula.

EVA 334960 EVA = NOPAT – (WACC * capital invested)

d. We should accept the project based on the ans of above 3 question. EPS is increasing, EVA is positive and PV of the project is also positive.

e.

jeff jeffy answered 2 years ago
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