Finance Problem
(Not rated)
(Not rated)
| Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemplating a $1,000,000 investment in a new production facility. The economic life of the facility is estimated to be five years, after which the facility will be obsolete and have no salvage value. | |||||||||||||||||||||||||||||||||
| To make the new facility operational, building improvements costing $400,000 will be required. In addition, a $50,000 increase in working capital will be needed. | |||||||||||||||||||||||||||||||||
| Bender's accounting and marketing departments have provided the following information: the firm will use the straight-line method of depreciation; the Company is in the 30% tax bracket; the weighted average cost of capital is 8%. | |||||||||||||||||||||||||||||||||
| Here are Earnings before Interest and Taxes (EBIT) estimates for the new facility: | |||||||||||||||||||||||||||||||||
| Year 1.........$80,000 | |||||||||||||||||||||||||||||||||
| Year 2.......$100,000 | |||||||||||||||||||||||||||||||||
| Year 3.......$120,000 | |||||||||||||||||||||||||||||||||
| Year 4........$140,000 | |||||||||||||||||||||||||||||||||
| Year 5.......$165,000 | |||||||||||||||||||||||||||||||||
| Your assignment is to answer the following questions: | |||||||||||||||||||||||||||||||||
| 1. Diagram the cash flows for the project using a time line. For each of Years 1 through 5, include the following data on your diagram (in this order) : EBIT, tax, depreciation, Operating Cash Flow (OCF), and discounted OCF. | |||||||||||||||||||||||||||||||||
| 2. Indicate the initial investment cost, the present value, the Net Present Value (NPV), and the payback (measured in years based on non-discounted OCF numbers). | |||||||||||||||||||||||||||||||||
| 3. Evaluate the project's efficacy. Is this facility worthwhile, based upon your calculations ? Why or why not ? What does the NPV decision rule indicate for this project ? If you were Bender's financial manager, what other factors would you consider before deciding whether or not to recommend construction of the production facility ? | |||||||||||||||||||||||||||||||||
| Case Problem 5 | |||||||||||||||||||||||||||||||||
| Touring Enterprises, Inc., has a capital structure consisting of $18 million in long-term debt and $7 million in common equity. There is no preferred stock outstanding. | |||||||||||||||||||||||||||||||||
| The interest rate paid on the long-term debt is 10%. The firm is in the 35% tax bracket. | |||||||||||||||||||||||||||||||||
| On the common equity (stock), the Company pays an annual dividend of $1.20 and expects to increase the dividend by 5% per year. The market price of the stock is $50. | |||||||||||||||||||||||||||||||||
| Based on this information, answer the following questions: | |||||||||||||||||||||||||||||||||
| 1. Calculate Touring Enterprises' weighted average cost of capital (WACC). Work as follows: first, compute the after-tax cost of debt, then compute the cost of equity. Cite both formulas, and show all your work. | |||||||||||||||||||||||||||||||||
| Then, determine the weightings of debt and equity in the capital structure. | |||||||||||||||||||||||||||||||||
| Lastly, using your answers to the above questions, calculate the WACC. | |||||||||||||||||||||||||||||||||
| 2. If Touring Enterprises were to increase the percentage of debt in its capital structure, what would happen to the WACC ? No calculation is necessary- simply provide a short, non-numeric response. | |||||||||||||||||||||||||||||||||
| 3. Identify and explain the benefits and risks of debt financing. A two-paragraph answer will suffice. | |||||||||||||||||||||||||||||||||
13 years ago
Finance Problem
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