Question

I need Help with section three and for section 1 and 2 to be looked over. I think I have the write answers just needing help.

Capital Budgeting Assignment – Part 1

CAPITAL BUDGETING CASE STUDY ANALYSIS

ACME Inc. is a multinational conglomerate corporation providing a wide range of goods and services to its customers. As part of its budgeting process for the next year, it has several projects under consideration so it must decide which projects should receive capital budgeting investment funds for this year.

As part of the financial analysis department, you have been given several projects to evaluate. However, before you can determine the appropriate valuations of these projects, you need to determine the weighted average cost of capital for the firm since it is used as a threshold of acceptability for projects.
Remember that management has a preference in using the market values of the firm’s capital structure andbelieves it current structure (target weight/market weight) is optimal.

Market Values of Capital

1. The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent semi-annual coupon, and are currently selling for $874.78.

2. You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00.

3. The company has 5 million shares of common stock outstanding with a currently price of $17.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.65.

4. The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 13percent. Your stock’s beta is 1.22.

5. Your firm only uses bonds for long-term financing.

6. Your firm’s federal + state marginal tax rate is 40%. (Ignore any carryforward implications)

Depreciation Schedule

Modified Accelerated Cost Recovery System (MACRS)

Ownership Year	5-Year Investment Class Depreciation Schedule
1	20%
2	32%
3	19%
4	12%
5	11%
6	6%
	Total = 100%

Section 1 (10% of total grade)

Find the costs of the individual capital components:

1. long-term debt (before tax and after tax)

Before Tax:

=(50+((1000-874.78)/15))/((1000+874.78)/2)

=0.062245 or 6.2245%

After tax:

= 6.2245 * (1- Tax rate)

= 6.2245 * ( 0.6)

= 3.7347%

2. preferred stock

=Dividend / Price of preferred stock

= (9% of par value) / 90

=9/90

=.1 or 10%

3. average cost of retained earnings (avg. of Capital Asset Pricing Model & Gordon Growth Model/Constant Growth Model)

By CAPM = Risk free rate + (Beta * (MArket risk premium - Risk free rate))

= 6 + (1.22 * (13-6)

=14.54%

By Gordan growth model = (D0 * (1+ growth rate of divident)) / price of stock

=.65 (1+0.1) / 17

=0.0421

Avg of CAPM and gordan gowth

=(14.54 + 4.2) / 2

=18.74/ 2

= 9.37%

Section 2 (10% of total grade)

Determine the target percentages for the optimal capital structure, and then compute the WACC. Carry weights to a minimum of four decimal places, but rounding in calculations is not necessary. (i.e. 0.2973 or 29.73%)

Long term debt = 60000 * 874.78 = 52,486,800

Preferred stock = 100000 * 90 = 9,000,000

Equity = 5,000,000 * 17 = 85,000,000

Total value of firm = 52,486,800 + 9,000,000 + 85,000,000 = 146,486,800

Weight of Debt = 52,480,800 / 146,486,800 = 0.3583

Weight of preferred stock= 9,000,000 / 146,486,800 = 0.06143

Weight of Equity = 85,000,000 / 146,486,800 = 0.5803 or 58.03%

WACC = Wd*Kd(1-T)+We*Ke+Wp*Kp

=0.3583*7.08%+0.5803*14.37%+.0614*10%

=11.49%

Section 3, Part 1 (30% of total grade)

Select one (1) of the projects assignment and create a valuation spreadsheet for the project provided by your instructor. You should use your Use the spreadsheet template provided to structure your valuation analysis. Evaluate each project according to the following valuation methods:

1. Net Present Value of Discounted Cash Flow (use WACC number for discount rate)
2. Internal Rate of Return
3. Payback Period

Profitability Index (use WACC number for discount rate)

Project L:

This project requires an initial investment of $2,000,000 in equipment which will cost an additional $75,000 to install. The firm will use the attached MACRS depreciation schedule to expense this equipment. Once the equipment is installed, the company will need to increase net working capital by $100,000. The project will last 6 years at which time the market value for the equipment will be $180,000.

The project will project a product with a sales price of $32.00 per unit and the variable cost per unit will be $11.00. The fixed costs would be $110,000 per year. Because this project is very close to current products sold by the business, management wants you to apply the WACC as the discount rate to the project.

Years	2014	2015	2016	2017	2018	2019
Forecasted Units Sold	32,000	45,000	48,000	58,000	75,000	90,000

1 Initial Project Scenario Inflation Rate Tax Rate 2 Price 3 Variable Cost 4 Units sold 5 Depreciation Rate 6 Required Return 7 Salvage Value 8 Initial Cost 9 Installation Cost 10 Increase in NWC 11 Fixed Cost ----- - - - - - - - - - - - - -- - - - - - - - - - 12 1 2 3 4 5 6 13 Sales 14 Variable Cost 15 Fixed Cost 16 EBITDA 17 Depreciation 18 EBIT 19 Tax Expense 20 Net Income 21 22 Operating Cash Flow 23 Non-operating Cash Flow 24 Net Working Capital 25 Year 0 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 26 27 28 Internal Rate of Return 29 Net Present Value 30 Payback Period 31 Profitability Index 32 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 33

Answer 1

Section 1:

Section 1 (10% of total grade)

Find the costs of the individual capital components:

1. long-term debt (before tax and after tax)

Before Tax:

=(50+((1000-874.78)/15))/((1000+874.78)/2)

=0.062245 or 6.2245%

After tax:

= 6.2245 * (1- Tax rate)

= 6.2245 * ( 0.6)

= 3.7347%

Comment: - Not Correct Methodology

Correct Process: To compute this we will need the Par value of the Bond. In the query, it’s not provided.

2. preferred stock

=Dividend / Price of preferred stock

= (9% of par value) / 90

=9/90

=.1 or 10%

Comment: - Correct Methodology

3. average cost of retained earnings (avg. of Capital Asset Pricing Model & Gordon Growth Model/Constant Growth Model)   

By CAPM = Risk free rate + (Beta * (MArket risk premium - Risk free rate))

= 6 + (1.22 * (13-6)

=14.54%

Comment: - Correct Methodology

By Gordan growth model = (D0 * (1+ growth rate of dividend)) / price of stock

=.65 (1+0.1) / 17

=0.0421

Comment: - Correct Methodology

Avg of CAPM and gordan gowth

=(14.54 + 4.2) / 2

=18.74/ 2

= 9.37%

Section 2

Cost of Debt is missing as Par value of Bond is not provided. If one can get the value following methodology to be used

	No. of shares / Bonds	Value	Total Value	Weights
Debt	60,000	874.78	52,486,800	35.83%	Wd
Equity	5,000,000	17	85,000,000	58.03%	We
Preferred Stock	100,000	90	9,000,000	6.14%	Wp
Total			146,486,800
Formula
WACC	Wd*Kd(1-T)+We*Ke+Wp*Kp
Where
Wd	Weight of Debt as calculated from above
We	Weight of Equity as calculated from above
Wp	Weight of preferred share as calculated from above
Kd	Cost of debt	????	More details required
Ke	Cost of Equity	14.54%	From section 1
Kp	Cost of Preferred Share	10%	From Section 1

Section 3

Here is the entire computation sheet

IRR and NPV can't be calculated as we are not able to compute WACC in Section 2. If one can get the par value of Bonds the entire computation can be done

			Yearly Variables
		Per year / Per unit	Y0	Y1	Y2	Y3	Y4	Y5	Y6
a	Price	$                             32
b	Variable cost	$                             11
c	Units Sold			32000	45000	48000	58000	75000	90000
d	Depreciation Rate			20%	32%	19%	12%	11%	6%
e	Required Rate
f	Salvage value	$                   180,000
g	Initial Cost		$   2,000,000
h	Installation Cost		$         75,000
i	Increase in NWC	$                   100,000
j	Fixed Cost	$                   110,000
k	Tax Rate	40%
1	Sales - from above			$   1,024,000	$ 1,440,000	$ 1,536,000	$ 1,856,000	$ 2,400,000	$ 2,880,000
2	Variable Cost - from above			$       352,000	$     495,000	$     528,000	$     638,000	$     825,000	$     990,000
3	Fixed Cost - from above			$       110,000	$     110,000	$     110,000	$     110,000	$     110,000	$     110,000
4	EBITDA - (1 - 2- 3)			$       562,000	$     835,000	$     898,000	$ 1,108,000	$ 1,465,000	$ 1,780,000
5	Depreciation - (g+h) * dep rate			$       415,000	$     664,000	$     394,250	$     249,000	$     228,250	$     124,500
6	EBIT - (4-5)			$       147,000	$     171,000	$     503,750	$     859,000	$ 1,236,750	$ 1,655,500
7	Tax Expense - ( 6 * ( Tax Rate)			$         58,800	$        68,400	$     201,500	$     343,600	$     494,700	$     662,200
8	Net Income - (6-7)			$         88,200	$     102,600	$     302,250	$     515,400	$     742,050	$     993,300
9	Add: Depreciation			$       415,000	$     664,000	$     394,250	$     249,000	$     228,250	$     124,500
10	Add: Salvage value								$     180,000
11	Add: Working capital recovered								$     100,000
12	Operating Cash Flow - (9 + 10 + 11)		$ (2,075,000)	$       503,200	$     766,600	$     696,500	$     764,400	$     970,300	$ 1,397,800
	Cummulative Cash flow			$ (1,571,800)	$   (805,200)	$   (108,700)	$     655,700	$ 1,626,000	$ 3,023,800
	Non-Operating Cash Flow
	Net Working Capital
	WACC	?????
	IRR		Not possible to calculate as WACC computation is not possible due to non-availability of par value of bonds
	Net Present Value		Not possible to calculate as WACC computation is not possible due to non-availability of par value of bonds
	Payback Period	4
	Profitability Index		Not possible to calculate as WACC computation is not possible due to non-availability of par value of bonds