Question

Ramblin Wreck is a firm specializing in engineering components. The firm is publicly traded and is considering the following project: The project will last 5.00 years with an annual cash flow of $40.00 million. The project will require an initial investment of $140.00 million The firm must determine the cost of capital to evaluate the project. (The project is within the firm’s normal activities) Ramblin Wreck, Inc. Financial Data: STOCK DATA: BOND DATA: Current Price Per Share $30.00 Current Price Per Bond $931.00 # of Shares 2.00 million # of bonds 20,000.00 Book Value $50 million Annual Coupon Rate 8.00% Face Value Per Bond $1,000 Maturity 10 years The risk free rate in the economy is currently 2.00%, while investors have a market risk premium of 8.00%. Ramblin Wreck, Inc. has a beta of 1.44. The tax rate is 36.00%.

What is the yield to maturity on Ramblin Wreck, Inc. bonds?

What is the cost of equity?

What is the weight in debt for the project?

What is the WACC for the project?

What is the NPV of the project? (express in millions, so 1000000 would be 1.00)

Answer 1

Answer :

(i.) Calculation of  yield to maturity on Ramblin Wreck, Inc. bonds :

Yield to maturity = {Coupon + [(Face Value - Price) / Number of years to maturity]} / [(Face Value + Price) / 2]

={(1000 * 8%) + [(1000 - 931) / 10]} / [(1000 + 931) / 2]

= {80 + 6.9} / 965.5

= 86.9 / 965.5

= 9%

(ii.) Calculation of Cost of Equity

Cost of Equity = Risk Free rate + (Beta * Market Risk premium)

= 2% + (1.44 * 8%)

= 13.52%

(iii) Weight of Debt = Debt Value / Total Value

= (Number of Bonds * Current price per bond) /  [(Number of Bonds * Current price per bond) + ( (Number of Shares * Current price per share)]

= (20,000 * 931) / [(20000 * 931) + (2,000,000 * 30)

= 18,620,000 / [18,620,000 + 60,000,000]

= 18,620,000 / 78,620,000

= 0.23683541083 or 0.2368

(iv) Calculation of WACC

WACC = ( Cost of Equity * Weight of Equity) + (Cost of after tax debt * Weight of Debt)

= [13.52% * (1 - 0.2368)] + [9% * (1 - 0.36) * 0.2368]

= 10.32% + 1.36%

= 11.68%

(v) Calculation of NPV of the project :

Net Present value = Present value of Cash Inflow - Presen value of cash outflow

= (Annual Cash Inflow * PVAF @ 11.68% for 5 years) - 140 million

= (40 million * 3.63353681187) - 140 million

= 145.34 - 140 million

= 5.34 million

Note : WACC has been rounded to two digits as nothing is mentioned about rounsding off.