In: Finance
suppose ABC firm is considering an investment that would extend the life of one of its facilities for 5 years. the project will require upfront cost of 8 m plus (35+2) 37 millions investment in equipment. The equipment will be obsolete in 2 years and will be depreciated via straight line over that period (assume that the equipment can’t be sold). During the next 5 years ABC expect annual sales of 55 M per year from this facility. Material cost and operating expenses are expected to total 40 M and 6.8 M respectively per year. ABC expect no networking capital requirement for the project, and it pays a tax rate of 38%. ABC has 70% of equity and the remaining is in debt. if the cost of equity and debt are 8% and 6% respectively, should they take the project? a) WACC (in percentage, thus 3.8% must be entered as 3.8); b) Incremental FCF at 0; c) Incremental FCF from year 1 to year 5; d) NPV. All dollars’ answers must be submitted in Millions, thus 4.56M must be entered as 4.56. Round to the second decimal in each case.
a). WACC = (equity ratio*cost of equity) + (debt ratio*cost of debt*(1-Tax rate))
= (70%*8%)+(30%*6%*(1-38%)) = 6.716% or 6.7%
b). Incremental FCF at Time 0 = upfront cost + equipment cost = 8 + 37 = 45 million
c). Incremental FCFs calculation:
d). NPV = -11.23 million (Note: NPV has been calculated at the exact discount rate of 6.716% and not 6.7%, as the question does not specify it)
The project should not be undertaken as it is a loss making project given its negative NPV.