Question

Coca Cola Inc. is considering opening a new bottling plant in the Southeastern U.S. It anticipates that this plant will increase sales by $8 million per year over the next 15 years. Costs to operate the plant are estimated to be $3 million per year. The company estimates that the cost of constructing the plant along with the cost of the equipment will be $30 million. These costs can be depreciated using straight-line depreciation. At the end of 15 years, it is estimated that the equipment and facilities can be sold for $5 million. The plant will require an initial increase in the company’s working capital of $3 million. Funds to finance the plant will be raised in exactly the same proportion as Coca-Cola’s current financial structure. Coke maintains very low leverage. It currently has 15 million bonds outstanding that have $1000 face value and trade for 100% of par value. It has 2 billion outstanding shares, that currently trade for $60/share. The bonds have a beta of 0.05, while the stock has a beta of 0.50. The risk free rate is 6%, and the expected return on the S&P 500 is 14%. Coke is currently in the 35% tax bracket. Should Coke go ahead with the planned expansion?

Answer 1