Question

The following information pertains to Fairways Driving Range, Inc.:

The company is considering operating a new driving range facility in Sanford, FL. In order to do so, they will need to purchase a ball dispensing machine, a ball pick-up vehicle and a tractor and accessories for a total cost of $105,000. All of this depreciable equipment will be 7-year MACRS property. The project is expected to operate for 6 years, at the end of which the equipment will be sold for 25% of its original cost. Fairways expects to have $35,000 of fixed costs each year other than depreciation. These fixed costs include the cost of leasing the land for the driving range.

Fairways expects to have sales for the first year of $105,000 based on renting 21,000 buckets of balls @ $5 per bucket. For years 2-6, they expect the number of buckets rented to steadily increase by 1,100 buckets per year, while the price will remain constant @ $5. Expenditures needed for buckets and balls each year are expected to be 20% of the gross revenues for the year.

Fairways will be in the 40% tax bracket for all years in question.

The company has a required capital structure of 45% debt and 55% equity. They can issue new bonds to yield 5%. With respect to equity, the company’s beta is 1.75 the expected return on the market is 10% and the risk-free rate is 4%. Use this information to compute the company’s WACC and then use the WACC as the required return for this project.

Please complete the following tables to determine the NPV for Fairways Driving Range, Inc.’s proposed Sanford venture. PLEASE ROUND ALL FIGURES TO THE NEAREST WHOLE DOLLAR!

For each year of the project, compute the profit margin and EPS (assuming that the firm has 15,000 shares of stock outstanding). Besides the net value of the fixed assets, the company also expects to have $20,000 of other assets. Compute the total assets for each year, use the 45%/55% ratio to determine the total amounts of liability and equity for each year, and use those figures to compute ROA and ROE for each year.

Based on your financial analysis, prepare a paragraph or so of a summary from the stand point of a consultant. In this summary, provide your ideas about this project and what you think would be the best course of action for the company to follow and why. Remember to justify your answers with facts from your calculations as well as provide meaningful insight for the company.

	0*	1	2	3	4	5	6
Sales
Variable Costs
Fixed Costs
Depreciation
EBIT
Taxes
Net Income
EBIT
Depreciation
Taxes
OCF
Net Capital Spending	-$105,000
Cash Flow From Assets
Present Value
NPV (just put overall NPV in Year 0 column)
Profit Margin
EPS
Total Assets
Total Liabilities
Total Equity
ROA
ROE

WACC Computation:

*The only amounts that you will have for year 0 will be Net Capital Spending, Cash Flow from Assets, Present Value and the overall NPV.

Answer 1

	0*	1	2	3	4	5	6
		21,000	22,100	23,200	24,300	25,400	26,500
Sales		1,05,000	1,10,500	1,16,000	1,21,500	1,27,000	1,32,500
Variable Costs		21,000	22,100	23,200	24,300	25,400	26,500
Fixed Costs		35,000	35,000	35,000	35,000	35,000	35,000
Depreciation		15,000	15,000	15,000	15,000	15,000	15,000
EBIT		34,000	38,400	42,800	47,200	51,600	56,000
Taxes		13,600	15,360	17,120	18,880	20,640	22,400
Net Income		20,400	23,040	25,680	28,320	30,960	33,600
EBIT		34,000	38,400	42,800	47,200	51,600	56,000
Depreciation		15,000	15,000	15,000	15,000	15,000	15,000
Taxes		13,600	15,360	17,120	18,880	20,640	22,400
OCF		35,400	38,040	40,680	43,320	45,960	48,600
Net Capital Spending	-1,05,000	-	-	-	-	-	-
Cash Flow From Assets	-1,05,000	35,400	38,040	40,680	43,320	45,960	74,850
Present Value	-1,05,000	32,381	31,827	31,133	30,326	29,429	43,840
NPV (just put overall NPV in Year 0 column)	93,937
Profit Margin		19.43%	20.85%	22.14%	23.31%	24.38%	25.36%
EPS		1.36	1.54	1.71	1.89	2.06	2.24
Total Assets	1,25,000	1,10,000	95,000	80,000	65,000	50,000	35,000
Total Liabilities	56,250	49,500	42,750	36,000	29,250	22,500	15,750
Total Equity	68,750	60,500	52,250	44,000	35,750	27,500	19,250
ROA	-	0.19	0.24	0.32	0.44	0.62	0.96
ROE	-	0.34	0.44	0.58	0.79	1.13	1.75
Assets	0*	1	2	3	4	5	6
Fixed Assets	1,05,000	1,05,000	90,000	75,000	60,000	45,000	30,000
Depreciation		15,000	15,000	15,000	15,000	15,000	15,000
Net Value of Fixed Assets	1,05,000	90,000	75,000	60,000	45,000	30,000	15,000
Other Assets	20,000	20,000	20,000	20,000	20,000	20,000	20,000
Total assets	1,25,000	1,10,000	95,000	80,000	65,000	50,000	35,000

The net present value of the project is positive of $93937. Revenue from operations are impressing with capital spending withing the financial boundary of the company. The company should invest in the project, it will generate great value to the equity holders of the company after paying off the debtholders of the company.

WACC Computation:

Weight of Debt*Cost of Debt*(1-t) + Weight of equity*cost of equity

=0.45*0.05*0.6 + 0.55*0.145

=9.33%

Cost of equity= Risk free rate+ Beta*(Market rate-risk free rate)

= 0.04+ 1.75*(0.1-0.04)

=14.5%