Question

Compute the cost of debt financing. Compute the cost of equity financing using the capital asset pricing model. Compute the weighted average cost of capital. The capital investment is to be depreciated as a 7 year asset using this table: Ownership year 1 (14.29%), year 2 (24.49%), year 3 (17.49%), year 4 (12.49%), year 5 (8.93%), year 6 (8.92%), year 7 (4.46%). Evaluate each independent project by computing net present value, internal rate of return, and payback. Then decide whether to accept or reject the project.

Debt 40%, interest rate 5%, tax rate 26%, equity 60%, risk free rate 6%, RM 13%, beta 1.10, working capital 10% next year's sales, no terminal cash flows

project 1 capital investment 1,000,000 year 1(revenue 780,000, expenses 585,000) year 2(revenue 799,500,expenses 599,625) year 3(revenue 819,488, expenses 614,616) year 4(revenue 839,975, expenses 629,981) year 5 (revenue 860,974, expenses 645,731) year 6 (revenue 882,498, expenses 661,874) year 7 (revenue 904,561, expenses 678,421) year 8 (revenue 927,175, expenses 695,381)

project 2 capital investment 750,000 year 1(revenue 800,000, expenses 600,000) year 2 (revenue 820,000, expenses 615,000) year 3 (revenue 840,500, expenses 630,375) year 4 (revenue 861,513, expenses 646,134) year 5 (revenue 883,050, expenses 662,288) year 6 (revenue 905,127, expenses 678,845) year 7 (revenue 927,755, expenses 695,816) year 8 (revenue 950,949, expenses 713,211)

project 3 capital investment 1,000,000 year 1 ( revenue 850,000, expenses 680,000) year 2 (revenue 871,250, expenses 697,000) year 3 (revenue 893,031, expenses 714,425) year 4 (revenue 915,357, expenses 732,286) year 5 ( revenue 938,241, expenses 750,593) year 6 (revenue 961,697, expenses 769,358) year 7 (revenue 985,739, expenses 788,592) year 8 (revenue 1,010,383, expenses 808,306)

Answer 1

Cost of Equity					Amount of Equity
	Riskfree rate		6.00%			Shares		60
	Beta		1.10			Price		1
	Market return		13.00%			Value		60
	Cost of Equity		13.70%
Cost of Debt					Amount of Debt
	Rate		5.00%			Book value		40
	Taxrate		26%			Adjustment		1
	Cost of Debt		3.70%			Value		40
					Total Capital			100
WACC			9.70%

Copyright 2017 Money-zine.com	discounting rate	9.70%		Tax	26%
	Y0	1	2	3	4	5	6	7	8
Project 1
New equipment cost	$     (1,000,000)
Revenue		$         780,000	$         799,500	$         819,488	$         839,975	$         860,974	$         882,498	$         904,561	$         927,175
Expanses		$        (585,000)	$        (599,625)	$        (614,616)	$        (629,981)	$        (645,731)	$        (661,874)	$        (678,421)	$        (695,381)
Cash Before Tax		$         195,000	$         199,875	$         204,872	$         209,994	$         215,243	$         220,624	$         226,140	$         231,794
Depreciation		$   (142,900.00)	$   (244,900.00)	$   (174,900.00)	$   (124,900.00)	$     (89,300.00)	$     (89,200.00)	$     (44,600.00)	$     (89,300.00)
Operating profit		$      52,100.00	$     (45,025.00)	$      29,972.00	$      85,094.00	$    125,943.00	$    131,424.00	$    181,540.00	$    142,494.00
Income Tax		$     (13,546.00)	$                 -	$       (7,792.72)	$     (22,124.44)	$     (32,745.18)	$     (34,170.24)	$     (47,200.40)	$     (37,048.44)
Cash Flow after Tax		$    181,454.00	$    199,875.00	$    197,079.28	$    187,869.56	$    182,497.82	$    186,453.76	$    178,939.60	$    194,745.56
PV ( cash Flow)		$    165,409.30	$    166,090.66	$    149,286.69	$    129,726.86	$    114,874.74	$    106,987.09	$      93,596.60	$      92,856.98
NPV of Cash flow	$      18,828.92
Payback	7 year 9 months
IRR 10.214%
Project 2
New equipment cost	$        (750,000)
Revenue		$         800,000	$         820,000	$         840,500	$         861,513	$         883,050	$         905,127	$         927,755	$         950,949
Expanses		$        (600,000)	$        (615,000)	$        (630,375)	$        (646,134)	$        (662,288)	$        (678,845)	$        (695,816)	$        (713,211)
Cash Before Tax		$         200,000	$         205,000	$         210,125	$         215,379	$         220,762	$         226,282	$         231,939	$         237,738
Depreciation		$   (107,175.00)	$   (183,675.00)	$   (131,175.00)	$     (93,675.00)	$     (66,975.00)	$     (66,900.00)	$     (33,450.00)	$     (66,975.00)
Operating profit		$      92,825.00	$      21,325.00	$      78,950.00	$    121,704.00	$    153,787.00	$    159,382.00	$    198,489.00	$    170,763.00
Income Tax		$     (24,134.50)	$       (5,544.50)	$     (20,527.00)	$     (31,643.04)	$     (39,984.62)	$     (41,439.32)	$     (51,607.14)	$     (44,398.38)
Cash Flow after Tax		$    175,865.50	$    199,455.50	$    189,598.00	$    183,735.96	$    180,777.38	$    184,842.68	$    180,331.86	$    193,339.62
PV ( cash Flow)		$    160,314.95	$    165,742.07	$    143,619.65	$    126,872.55	$    113,791.80	$    106,062.65	$      94,324.84	$      92,186.61
NPV of Cash flow	$    252,915.11
Payback 5 years 5 months
IRR 18.343%
Project 3
New equipment cost	$     (1,000,000)
Revenue		$         850,000	$         871,250	$         893,031	$         915,357	$         938,241	$         961,697	$         985,739	$      1,010,383
Expanses		$        (680,000)	$        (697,000)	$        (714,425)	$        (732,286)	$        (750,593)	$        (769,358)	$        (788,592)	$        (808,306)
Cash Before Tax		$         170,000	$         174,250	$         178,606	$         183,071	$         187,648	$         192,339	$         197,147	$         202,077
Depreciation		$   (142,900.00)	$   (244,900.00)	$   (174,900.00)	$   (124,900.00)	$     (89,300.00)	$     (89,200.00)	$     (44,600.00)	$     (89,300.00)
Operating profit		$      27,100.00	$     (70,650.00)	$        3,706.00	$      58,171.00	$      98,348.00	$    103,139.00	$    152,547.00	$    112,777.00
Income Tax		$       (7,046.00)	$      18,369.00	$          (963.56)	$     (15,124.46)	$     (25,570.48)	$     (26,816.14)	$     (39,662.22)	$     (29,322.02)
Cash Flow after Tax		$    162,954.00	$    192,619.00	$    177,642.44	$    167,946.54	$    162,077.52	$    165,522.86	$    157,484.78	$    172,754.98
PV ( cash Flow)		$    148,545.12	$    160,061.13	$    134,563.37	$    115,969.70	$    102,021.02	$      94,976.95	$      82,374.39	$      82,371.61
NPV of Cash flow	$     (79,116.72)
Payback In sufficient data
IRR 7.472%