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In: Finance

These are the cash flows. Year 0 1 2 3 4 5 6   Revenue 3.2000 4.0000...

These are the cash flows.

Year

0

1

2

3

4

5

6

  Revenue

3.2000

4.0000

5.6000

5.6000

4.0000

2.4000

  Expenses

.7200

.9000

1.2600

1.2600

.9000

.5400

  Depreciation

.9500

.9500

.9500

.9500

.9500

.9500

  Pretax profit

1.5300

2.1500

3.3900

3.3900

2.1500

.9100

  Tax

.5355

.7525

1.1865

1.1865

.7525

.3185

  Net income

.9945

1.3975

2.2035

2.2035

1.3975

.5915

  OCF

1.9445

2.3475

3.1535

3.1535

2.3475

1.5415

  

  Cash flow investment

−5.7000

.4362

   Change in NWC

−.3200

−.0800

−.1600

0.0000

.1600

.1600

.2400

  OCF

0.0000

1.9445

2.3475

3.1535

3.1535

2.3475

1.5415

  Total cash flow

−6.0200

1.8645

2.1875

3.1535

3.3135

2.5075

2.2177

Use this detail to determine answers to the questions below.

Ray’s Racks is a publicly traded company.  The current stock price is $3.00 per share, and there are 20 million shares outstanding.  The present value of the company’s debt is $40,000,000.  The company has a bond issue outstanding with 6 years to maturity.  The face value is $1,000, the coupon rate is 8% (paid quarterly), and the bond is currently selling for $1,020.  The company’s corporate tax rate is 35% and their beta is 1.41.  The current risk free rate is 5%, and the historic market return is 12%.

NOTE: It is critical that you do not round intermediate calculations. For example, while you may provide the after-tax cost of debt rounded to two decimal places, DO NOT calculate the WACC using rounded numbers. DO NOT calculate the NPV using a WACC that was rounded to two decimal places. These will give you incorrect answers. Provide each answer as requested, but DO NOT round intermediate calculations.

Question 1. What is the weighting to be used for equity in the WACC calculation?

Question 2. What is the weighting to be used for debt in the WACC calculation?

Question 3. What is the project's NPV?

Solutions

Expert Solution

Answer (1):

Market value of equity =  current stock price * Number of shares outstanding = 3 * 20 = $60 million

Value of debt = $40,000,000 = $40 million

Total market value = 60 + 40 = $100 million

Weighting to be used for equity in the WACC calculation = 60 / 100 = 60%

Weighting to be used for equity in the WACC calculation = 60%

Answer (2):

Weighting to be used for debt in the WACC calculation = 40 / 100 = 40%

Weighting to be used for debt in the WACC calculation = 40%

Answer (3):

NPV = 4.63155874863646

(amount is not rounded)

Working:

Let us calculated WACC:

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

= 5% + 1.41 * (12% - 5%)

= 14.87%

Cost of debt:

Price = PV = $1020

Par value =FV = $1,000

Quarlty coupon = 1000 * 8%/4 = $20

Time to maturity in quarters = 6 * 4 = 24

Quartely cost of debt = RATE(nper, pmt, pv, fv, type) = RATE(24, 20, -1020, 1000, 0) = 1.89550536187566%

Before tax cost debt = 1.89550536187566% * 4 = 7.58202144750264%

WACC = Cost of equity * weight of equity + Before tax cost of debt * (1 - Tax rate) * Weight of debt

= 14.87% * 60% + 7.58202144750264% * (1 - 35%) * 40%

= 10.8933255763507%

NPV Calculation:

The above excel with 'show formula' is as follows:

jeff jeffy answered 1 year ago
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