Question

As you know, we have three major capital issues outstanding at this time. We have 1,200
15 year, 5% coupon bonds that are currently priced at 98. These $1,000 bonds pay interest semi-annually. We also have 12,000 shares of 4.5% preferred stock. The $100 par value stock currently sells for $87. Finally, we have 120,000 shares of common stock. Our common stock is selling for $48 a share. Our stock has a beta of 1.2 in the market that has a 3% risk free rate and a market risk premium of 6.5%.

Here’s what I have in mind. I’d like to consider installing a ropes course on the site for the next five years. We currently have a piece of the land that is on the books for $180,000. A local developer recently offered to pay us $220,000 for the land, but I think it is much more exciting to consider the ropes course. We think the land can be sold for $260,000 at the end of the life of the project. We estimate that we would have to spend $180,000 to install the series of rope course structures. We can depreciate these capital assets straight-line over a 6-year life and we believe that we can sell them to another operator for at end of the project for $25,000. We will also need to invest $32,000 in net working capital at the beginning of the project. We will recover that amount in full at the end.

It’s actually fairly reasonable to operate the course. The variable cost per visit is $35.50 and the annual fixed costs are $46,000. We believe that we can sell tickets for 30,000 visits a year. We believe that this project carries risk slightly higher than our normal risk, so we will add a 1.5% risk adjustment in computing the required rate of return. Our tax rate is 35%.

1a) Prepare a spreadsheet that provides an analysis of the project and indicates the minimum ticket price we will have to charge in order to make this project acceptable (NPV=0).

Hint: Calclate the PVA of OCF that would make the NPV=0 and then plug that into this equation and solve for P to calculate bid price OCF = [P-VC)Q-FC] * (1-T) + D(T) Assume for the remainder of the assignment that the company adopts this minimum price. Label that tab “Bid Price”

b) Prepare a worksheet that uses your minimum price and the other facts of the problem to confirm that, at the minimum price per round, the NPV of the project is zero.

Answer 1