Question

A firm producing digital cameras considers a new investment which is about opening a new plant. The project’s lifetime is estimated as 5 years and requires 22 million TL as investment cost. Salvage value of the project is estimated as 4 million TL (which will be received in the sixth year) However firm prefers to show salvage value only as 2 million TL. Firm uses 5-year straight line depreciation. It is estimated that the sales will be 12 million TL next year and then sales will grow by 20% each year. It is estimated that fixed costs will be 1.5 million next year and then will grow by 5% each year. Variable costs are projected %10 of sales each year. This project, in addition, requires a working capital of $ 3 million in the first year, 4 million in the second year, 4 million in third year, 3 million in the fourth year and 1.5 million in the fifth year. Firm plans to use a debt/equity ratio of %50 in this project. The company can borrow TL loan with an interest cost of 14% before tax. Corporate tax rate is 20%. The shares of this company in Borsa Istanbul are selling at 8 TL and the stocks have approximately market risk and have strong correlation with BIST100 index. 10- year government bond yields at %12 and market risk premium is %8. Given this information; find the NPV and IRR of the project; is this project feasible or not? If you want, you can solve this question using excel. What is the result of higher WACC ? Can a company reduce its WACC ? If yes, how? Give numerical example related with this project and explain this topic briefly regarding to the capital structure theories.

Answer 1

Company can reduce WACC by changing the leverage .If the debt component increases, WACC will reduce