Question

Relevant Information on Company ABC and Project P (The New Show):

• Company ABC is now selling for $21 per share and has 14,500,000 outstanding common shares.
• Company ABC has an equity (?) of 0.93.
• A dividend of $0.51 was just paid to all of the common shareholders and analysts estimate that it will grow steadily at 5% per year.
• Company ABC is now selling for $25 per share and has 1,550,000 outstanding preferred shares with a $2.5 dividend.
• Company ABC has an AA rating bond, currently quoted at 110.
• Company ABC’s coupon rate is 9.5% with semi-annual coupons.
• Company ABC has 76,000 outstanding bonds and time to maturity is 15 years.
• You also observe the beta (?) of 3 companies that focus on producing tv shows: Jimmy Kimmel Live - ? = 1.35, The Daily Show - ? = 1.07, and The View - ? = 1.24.
• The expected market return is 6.5%, the risk-free risk rate is 1.8%, and the corporate tax rate is 42%.

Additional Information on Company ABC and Project P (The New Show):

• The project is expected to last 4 years.
• Company ABC is planning to spend $2,100,000 on fixed assets such as equipment.
• John Smith (CEO) has already spent $140,000 on consultancy to check the feasibility of the project.
• Company ABC already bought an idle building (building that hasn’t been used yet) a few years ago.
• The ops manager suggested that the building is perfect to film Project P’s ‘The New Show’ and it is worthy of $500,000 if it is sold on the market today.
• The projected sales for the 4 years are: $1,600,000, $1,800,000, $1,700,000, and $1,900,000.
• The variable cost is 50% of the projected sales and the fixed cost is $550,000 per year.
• Company ABC estimates its increases in gross profit from other existing projects to be $6,000,000, $4,000,000, $5,000,000, and $7,000,000 for Years 1-4, respectively.
• Company ABC thinks 20%, 50%, 30%, 10% of these increases in gross profit, respectively, are due to the introduction of Project P.
• The initial net working capital is going to be $150,000, NWC increases by 200,000 for Y1, decreases by 77,000 for Y2, increases by 130,000 for Y3, and increases by 54,000 for Y4.
• Company ABC is expecting to recover 80% of its initial NWC at the end of the project.
• If the building and the equipment belong to Class 8, and there is an annual CCA rate of 20%, and the total capital spending is estimated to have a salvage value of $1,100,000 at the end of the project.

QUESTION: Find the NPV of this project today? (Find WACC using discount rate, CAPM for common shares and Dividend Discount Model for preferred shares when finding the cost of equity. When calculating cost of debt, use EAR, not YTM)

PLEASE SHOW ALL WORK AND STEP BY STEP CALCULATIONS!!!

Answer 1

Cost of Equity as per CAPM:

As we are caculating the WACC, to discount the New Show project's cash flows,

we will take the average betas of the three shows give, to be used in the CAPM formula,

ie. (1.35+1.07+1.24)/3=

1.22

so, as per CAPM, Cost of equity, ke=RFR(+Beta*(Market return-RFR))

ie.ke=1.8%+(1.22*(6.5%-1.8%))=

7.53%

Cost of preferred shares,

kps=$ dividend/market price per share

ie.2.5/25=

10.00%

EAR of bond(before-tax)=

(1+Annual rate/2)^2-1

1+(9.5%/2))^2-1=

9.7256%

so, the

after-tax EAR=

Before-tax EAR*(1-Tax rate)

ie.9.7256%*(1-42%)=

5.64%

Now, calculating the WACC

Type of capital			Wt. to total	Cost	Wt.*Cost
Equity	14500000*21=	304500000	71.34%	7.53%	5.37%
Pref.	1550000*25=	38750000	9.08%	10.00%	0.91%
Bond	76000*1000*110/100=	83600000	19.59%	5.64%	1.10%
Total		426850000	100.00%	WACC=	7.38%

Year	0	1	2	3	4
1.Initial investment	-2100000
2.After-tax sale value of old building(500000*(1-42%))	290000
3.NWC	-150000	-200000	77000	-130000	-54000
4.Recovery of initial NWC(150000*80%)					120000
5.ATCF on salvage(see wkgs.)					1044426
Operating cash flows:
6.Sales		1600000	1800000	1700000	1900000
7.Variable cost at 50%*sales		-800000	-900000	-850000	-950000
8.Fixed costs		-550000	-550000	-550000	-550000
9.Increase in G/Ps of existing project		1200000	2000000	1500000	700000
10.Depn.(see wkgs.)		-210000	-378000	-302400	-241920
11.EBIT(sum 6 to 10)		1240000	1972000	1497600	858080
12.Tax at 42%(11*42%)		-520800	-828240	-628992	-360394
13.EAT/NOPAT(11+12)		719200	1143760	868608	497686
14.Add Back:Depn.(Line 10)		210000	378000	302400	241920
15.Operating cash flows(13+14)		929200	1521760	1171008	739606
16.Total annual FCFs(1+2+3+4+5+15)	-1960000	729200	1598760	1041008	1850032
17.PV F at 7.38%(1/1.0738^ Yr.n)	1	0.93127	0.86727	0.80766	0.75215
18.PV at 7.38%(16*17)	-1960000	679084	1386553	840783	1391508
19.NPV at 7.38%(sum of Line 18)	2337927

Depreciation wkgs.
Year	Depn.	Book value
0		2100000
1	210000	1890000	2100000*20%/2 (50% Rule)
2	378000	1512000
3	302400	1209600
4	241920	967680	Book value
		1100000	Sale value
		132320	Gain on sale
		55574	tax at 42% on gain
		1044426	ATCF on salvage(1100000-55574)

Increase in G/Ps of existing project
6000000*20%=	1200000
4000000*50%=	2000000
5000000*30%=	1500000
7000000*10%=	700000