Question

Valuing a project using WACC Year Abracadabra Corp. is considering a project to expand its current business in potion making. The forecasted free cash flow is given on the right. Other potentially useful information is given below. (1) How would you suggest the company in this capital budgeting decision? (state clearly) FCF -1,000 1,323 1,569 3,288 1,029 1,425 622 3,800 3,800 3,800 2,700 (2) What is the key assumption underlying your suggestion above? (answer below) Book value of equity Market value of equity Total liability Market value of debt Market value of debt in the previous year Interest expense Corporate tax rate 8,000 10,000 20.000 15,000 15,000 900 40% Abracadabra's stock beta Expected return on S&P500 Risk-free rate 1.4 10% 4%

Answer 1

1. We can suggest a company to go forward with this project as it has a positive net present value of $13296.18, which is a good capital budgeting decision.
2.key underlying assumptions are:
1. Consideration of market values for calculation of the minimum acceptable rate of return instead of book value.
2. We have considered the weighted average cost of capital to be the minimum acceptable rate of return.
3. We have taken the npv method that is the net present value method for taking this capital budgeting decision.

1. Asper cApm Re= R + (RM-Rp) & = 4%. + (10-4) x 1.44. - 12.4% Rp - Risk free eate Rm= S&P Retuen Be Beta. Rd = Interest Expense = Market value of debt 900 Isovo 64 Corporate tax = 40%. WACC = weight of Equity & Cost of Equity & weight of deb (Market) Cost of debt = 10,000 X 12.49%. + 15,000 * 6/. 25,00 + 25,000 - 8.569. on the Minimimum acceptable rate of recen (MARR) 8-56% project. Capital Budgeting decision using NPV NPV (Ner present value) = present value of outflow. NPV- 1323 + 15694 3288 + 1029_1425 622 3800 1-0856 085632 (1.0856" CT-OPSC 1.08563(1-085336 (DE5607 270 3800 Tovo * Dokt 3800 (1086) t (10856 (1.08560 NPV = $13, 296.18