In: Finance
New consideration (emergency).
There was a huge mistake
Capital Structure | ||
Debt | 40% | |
Interest rate | 5% | |
Tax Rate | 26% | |
Equity | 60% | |
Risk Free rate | 6% | |
RM | 13% | |
Beta | 1% | |
Working capital | 10% next year's sales | |
No terminal cash flows | ||
Project 1 | Capital investment | 1,000,000 |
Year | Revenues | Expenses |
1 | 780,000 | 585,000 |
2 | 799,500 | 599,625 |
3 | 819,488 | 614,616 |
4 | 839,957 | 629,981 |
5 | 860,974 | 645,731 |
6 | 882,498 | 661,874 |
7 | 904,561 | 678,421 |
8 | 927,175 | 695,381 |
Instructions | ||
a) Compute the cost of debt financing | ||
b) Compute the cost of equity financing using the capital asset pricing model (CAPM) | ||
c) Compute the waighted average cost of capital (WACC) | ||
N.B. The capital investment is to be depreciatded as a 7 years asset | ||
d) Evaluate the project by computing: 1) Net Present Value (NPV) 2) Internal rate of return 3) Payback | ||
e) Decision is to accept or reject the projet (based on IRR and NPV) |
Use excel chart
a | after tax cost of debt | interest rate*(1-tax rate) | 5*(1-.26) | 3.7 | ||||||
b | cost of equity | risk free rate+(market return-risk free rate)*beta | 6+(13-6)*1 | 13 | ||||||
WACC | ||||||||||
source | weight | cost | weight*cost | |||||||
debt | 0.4 | 3.7 | 1.48 | |||||||
equity | 0.6 | 13 | 7.8 | |||||||
c | WACC = sum of weight*cost | 9.28 | ||||||||
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
Initial investment | -1000000 | |||||||||
revenue | 780000 | 799500 | 819488 | 839957 | 860974 | 882498 | 904561 | 927175 | ||
expenses | 585000 | 599625 | 614616 | 629981 | 645731 | 661874 | 678421 | 695381 | ||
less depreciation = 1000000/7 | 142857.143 | 142857.14 | 142857.14 | 142857.1429 | 142857.1429 | 142857.1429 | 142857.1 | 0 | ||
operating profit | 52142.8571 | 57017.857 | 62014.857 | 67118.85714 | 72385.85714 | 77766.85714 | 83282.86 | 231794 | ||
after tax profit = operating profit*(1-tax rate) | 38585.7143 | 42193.214 | 45890.994 | 49667.95429 | 53565.53429 | 57547.47429 | 61629.31 | 171527.56 | ||
operating cash flow = after tax profit+ depreciation | 181442.857 | 185050.36 | 188748.14 | 192525.0971 | 196422.6771 | 200404.6171 | 204486.5 | 171527.56 | ||
requiretment of working capital- | 78000 | 79950 | 81948.8 | 83995.7 | 86097.4 | 88249.8 | 90456.1 | 92717.5 | 0 | |
increase/ decrease of working capital | -78000 | -1950 | -1998.8 | -2046.9 | -2101.7 | -2152.4 | -2206.3 | -2261.4 | 92717.5 | |
net operating cash flow = operating cash flow+increase or decrease in working capital | -1078000 | 179492.857 | 183051.56 | 186701.24 | 190423.3971 | 194270.2771 | 198198.3171 | 202225.1 | 264245.06 | |
present value of net operating cash flow = net operating cash flow/(1+r)^n r = 9.28% | -1078000 | 164250.418 | 153282.32 | 143062.28 | 133523.4556 | 124653.0554 | 116373.9685 | 108655.1 | 129921.6078 | |
d | Net present value =sum of present value of cash flow | -4277.7881 | ||||||||
d | IRR = using IRR function in MS excel =irr(cell reference year 0 net operating cash flow: cell reference year 8 net operating cash flow) | 9.18% | ||||||||
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
net operating cash flow = operating cash flow+increase or decrease in working capital | -1078000 | 179492.857 | 183051.56 | 186701.24 | 190423.3971 | 194270.2771 | 198198.3171 | 202225.1 | 264245.06 | |
d | cumulative operating cash flow | 179492.857 | 362544.41 | 549245.65 | 739669.0486 | 933939.3257 | 144060.6743 | |||
amount to be recovered in year 6 | ||||||||||
payback period | year before final year of recovery+(amount to be recovered/cash flow of final year of recovery) | 5+(144060.67/198198.31) | 5.73 | |||||||
e | Reject the project as IRR is less than WACC and NPV is negative |