Question

23.   A firm is deciding on a new project. Use the following information for the project evaluation and analysis:

        - The initial costs are $900,000 for fixed assets. The fixed assets will be depreciated straight line to a zero book value over the 3-year life of the project. The fixed assets have an estimated salvage value of $60,000 at the end of the project.

        - The project also requires an additional $200,000 for net working capital. All of the networking capital will be recouped at the end of the 3 years.

        - The project is expected to generate sales of $2,000,000 (2,000 units at a sales price of $1,000/unit), incur total costs of $1,500,000 per year (comprised of variable cost of $500 per unit and fixed costs of $500,000).

        - The firm’s marginal tax rate is 40 percent.

- The company has 50,000 shares of common stock outstanding at a market price of $25 a share. The stocks have a beta of 1.5. The risk free rate is 1%, and the market risk premium is 10%.

        - There are 1,000 bonds outstanding which mature in 13 years, have a face value per bond of $1,000, and are currently quoted at $1,250 each. The bonds have a coupon rate of 10 percent.

        - The target capital structure is 50% debt and 50% equity.

a) What is the Operating Cash Flow for each year of the project?

b) What is the after-tax salvage value at the end of this project?

c) What are the Cash Flows from Assets each year for this project?

      Year               0                       1                          2                          3

           

      OCF

                  

? NWC

             

      NCS                                                                                                                        

      CFFA

d) Next, we are going to calculate WACC (part d) through h)). What is the capital structure weight of equity (w_E)?

e) What is the capital structure weight of debt (w_D)?

f) What is the cost of Debt (R_D)?

g) What is the cost of Equity (R_E)?

h) What is the WACC for this firm, if the corporate tax rate is 40%?

i) You have determined that the project is within the typical line of business of the company. What is the NPV for this project? (Hint: Use your WACC as your discount rate)

j) What is the IRR?

k) Based on your analysis what is your recommendation? Why?

Answer 1