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 $104,000. All of this depreciable equipment will be 5-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 $38,000 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 $104,000 based on renting 20,800 buckets of balls @ $5 per bucket. For years 2-6, they expect the number of buckets rented to steadily increase by 1,300 buckets per year, while the price will remain constant @ $4.50. Expenditures needed for buckets and balls each year are expected to be 23% of the gross revenues for the year.

Fairways will be in the 30% tax bracket for all years in question.

The company has a required capital structure of 30% debt and 70% equity. They can issue new bonds to yield 4.5%. With respect to equity, the company’s beta is 1.55 the expected return on the market is 14% and the risk-free rate is 5%. 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 16,000 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 30%/70% 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

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

ANSWER:-

Ke - Cost of Equity using CAPM Model Using CAPMto Calculate Cost of Equity Given RE 8 Rm - Rr+B (Rm-RD -Riskfree Rate of Retum - Beta - Market Expected Retur Rf-5% Rm=14% Beta=1.55 Ke= 19% D () + (ra) (1 - t) Ther Fore WACC Cost of Debt-4.5 Assume Equity is 16000 WACC = = D+E Where: E-market value of equity D=market value of debt cost of equity To cost of debt t=corporate tax rate Debt+Equ 22857.14 Debt= 6857.142 0133001 WACC 1496 0.00945

Years 1 0 20800 Fairways Driving Range 2 3 4 22100 23400 24700 4.5 4.5 45 Bucvkets Rate Increasee Buckets 5 26000 4.5 6 27300 4.5 1300 Sales 104000 99450 105300 111150 117000 122850 Vaiable Costs @ 23% of Sales) Fixed Costs Depreciation 23920 38000 20080 22873.5 38000 32128 24219 25564.5 26910 38000 38000 38000 19276.8 11566.08 11566.08 28255.5 38000 5783.04 Total Expenses EBIT Taxes (30%) Net Income 82000 22000 6600 15400 93001.5 81495.8 75130.58 76476.08 72038.54 6448.5 23804.2 36019.42 40523.9250811.46 1934.55 7141.26 10805.83 12157.18 15243.44 4513.95 16662.94 25213.59 28366.74 35568.02 20080 32128 im Add Depreciatiom Residual Value of Asets 19276.8 11566.08 11566.08 5783.04 26000 19276.8 11566.08 11566.08 31783.04 OCF 20080 3 2128 WACC Computation: NPV of Project 14% 82681.812 Book Value of Assetc (MACRS) Gross Profit 42080 80320 38576.5 48192 43081 289 15.2 17349.12 47585.5 52090 5783.04 56594.5 15% 5% 16% 0.9625 0.282122 1.041434 80320 48192 23% 24% 29% 1.57585 1.7729222 223001 28915.2 17349.12 25783.04 Profit Margin EPS Total Assets (Add 20K in year 6) Total Liabilities Total Equity ROA ROE