As a financialconsultant, you have contracted with Wheel lndustries

As a financialconsultant, you have contracted with Wheel lndustries to
evaluate their procedures involving the evaluation of long term
investment opportunities. You have agreed to provide a detailed report
iliustrating the use of several techniques for evaluating capital
projects including the weighted , ,r"ruge cost of-capitalto the firm,
the anticipated cash flows for.the Projects, and the methods used for
proJe;t selection. in addition, you have been asked to evaluate two
projects, incorporating risk into the calculations.
you have also
agreed to provide an 8-10 page report, in good form, with detailed
explanation of your methodology, findings, and recommendations.
Gompany Information
Wheel
lndustries is considering a three-year expansion project, Project A.
The project requires an initial investment of $1.5 million. The project
will use the straight-line depreciation method. The project has no
satvage value. lt is estimated that fhe project will generate additional
revenues of $1,2 million per year befor6 tax and has additional annual
costs of $600,000. The Marginal Tax rate is 357o
Required:
A.
Wheel has just paid a dividend of $2.50 per share. The dividends are
expected to grow at a constant rale of six percent per year forever. lf
the stock is currently selling for $50 per share with a 10a/o flotation
cost, what is the cost of new equity for the firm? What are the
advantages and disadvantages of using this type of financing for the
firm? B. The firm is considering using debt in its capital structure. lf
the market rate of 5% is appropriate for debt of this kind, what is the
after tiax cost of debt for the company? What are the advantiages and
disadvantages of using this type of financing for the firm? C. The firm
has decided on a capital structure consisting of 30o/o debt and 70'% new
common stock. Catculate the WACC and expiain how it is used in the
capital budgeting process. D. Calculate the after tax cash flows for the
project for each year. Explain the methods used in your calculations.
E. lf the discount rate were 6 percent calculate the NPV of the project.
ls this an economically acceptable project to undertake? Why or why
not? F. Now calculate the IRR for the project. ls this an acceptable
project? Why or why not? ls there a conflict between your answer to part
C? Explain why or why not?
Wheel has two other possible investment
opportunities, which are mutually exclusive, and independent of
Investment A above. Both investments will cost $120,000 and have a life
of 6 years. The after tax cash flows are expected to be the same over
the six year life for both projects, and the probabilities for each
year's after tax cash flow is given in the table below.
lnvestment B Probability ,After Tax rGash FIow : o?5 $2o,ooo 0.25 40,000
lnvestment C prooinitity rArtdr fax
io:30 ,0.50 10.r0
,Cash Flow $!z,oog -, .. 4-QrO0_0_ , 50,000
G.
What is the expected value of each projects annual after tiax cash
flow? Justiff your answers and identify any conflicts between the IRR
and the NPV and explain why these conflicts may occur.
I i'
H.
Assuming that the appropriate discount rate for projects of this risk
level is B%, what is the riskadjusted NPV ior each project? Which
project, if either, should be selected? Justiff your