Question

I only need part C solved as that is where I am stuck. if it could be done in steps showing how to get to the final answer that would be very helpful. I am posting for a second time because the first time it was answered here the anon put just the final answers.

OL: (17 points) Magnum Inc. is considering a new project, requiring an initial investment of SI million today. Assume the asset will be fully depreciated over the life of the project on a straight line basis. Revenues less expenses from this project (before taxes and excluding depreciation) are expected to be $3 million per year for 6 years. The project requires an immediate $200,000 increase in Net Working Capital. The new project falls within Magnum's main line of business (manufacturing car parts) and is no more or less risky than the overall firm. Magnum issued 100,000 15-year 10% semi-annual coupon bonds 6 years ago, with a face value of $1,000. Magnum's bonds are currently traded at par. Magnum has 10,000,000 shares of stock outstanding and the current stock price is $9. The beta of Magnum common stock is 1.2. The standard deviation of TSE 300 returns is 18%, the risk premium on the market portfolio is 8%, and the T- bill rate equals 5%. The effective marginal corporate tax rate is 35%. a. What is Magnum's cost of equity? b. What is Magnum's WACC? c Assume that the WACC for the above project is 10%. Calculate the NPV for this investment. Should Magnum implement this projegt?

Answer 1

c). CF0 = Initial investment + increase in NWC = -10,000,000 - 200,000 = -10,200,000

Depreciation/year = initial investment/life of the project = 10,000,000/6 = 1,666,666.67

Free Cash flows from year 1 to year 5:

OCF = (Revenue - cost)*(1-tax) + Depreciation*tax

= 3,000,000*(1-35%) + (1,666,666.67*35%) = 2,533,333.33

Since increase in NWC will now be zero and there is no added capex, so OCF = FCF.

Present Value of FCF: PMT = 2,533,333.33; I = 10%; N = 5, solve for PV. PV = 9,603,326.48

FCF for year 6: OCF + return of increase in NWC = 2,533,333.33 + 200,000 = 2,733,333.33

Present value of FCF6 = 2,733,333.33/(1+10%)^6 = 1,542,895.41

Total NPV = CF0 + PV of FCFs from year 1 to year 5 + PV of FCF6

= -10,200,000 + 9,603,326.48 + 1,542,895.41

= 946,221.89