Question

In: Finance

Ramblin Wreck is a firm specializing in engineering components. The firm is publicly traded and is...

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 $29.00 Current Price Per Bond $938.00
# 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 7.00%. Ramblin Wreck, Inc. has a beta of 1.49. The tax rate is 37.00%.

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

Submit

Answer format: Currency: Round to: 2 decimal places.

Solutions

Expert Solution

Cost of capital would be weighted average cost of capital
WACC Weight of equity*Cost of equity + (Weight of debt*Cost of debt*(1-tax rate))
Cost of equity using CAPM formula
Cost of equity (Ke) Rf + Beta*(Rm-Rf)
Risk free rate is Rf
Market return is Rm
Rm-Rf is risk premium
Cost of equity (Ke) 2% + (1.49*7%)
Cost of equity (Ke) 12.43%
Assuming coupon are paid annually as nothing is mentioned we calculate yield to maturity
Face value (FV) $1,000
Present value (PV) $938
No of payments (NPER) 10
Coupon amount (PMT) $80
Yield to maturity 8.96% RATE(10,-80,938,-1000)
After tax cost of debt 5.65% 8.96%*(1-0.37)
Market value of shares 2000000*29
Market value of shares $58,000,000
Market value of debt 938*20000
Market value of debt $18,760,000
Total market value of equity and debt $76,760,000
Weight of equity 75.56% 58000000/76760000
Weight of debt 24.44% 18760000/76760000
WACC (75.56%*12.43%)+(24.44%*5.65%)
WACC 10.77%
Calculate net present value
Year Cash flow Discount factor @ 10.77% Present value
0 -$140.00 1.0000 -$140.00
1 $40.00 0.9028 $36.11
2 $40.00 0.8150 $32.60
3 $40.00 0.7358 $29.43
4 $40.00 0.6642 $26.57
5 $40.00 0.5996 $23.99
Net present value $8.70
Thus, net present value is $8.70 million

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