| | Short Application problem 1 - part 2 |
| | 1) Calculate the new WACC |
| | We are told: |
| | Weights of 70% debt and 30% common equity (no preferred equity); this essentially reverses their previously calculated capital structure |
| | A 35% tax rate |
| | The cost of debt is now 9% due to an additional default risk premium |
| | The beta of the company is 1.3 |
| | The risk free rate is 2% |
| | The return on the market is 12% |
| | First calculate the expected cost of equity determined using the CAPM: |
| | |
| | CAPM = Risk Free Rate + Equity Beta * Market Risk Premium |
| | And we need to remember that market risk premium = Return on Market - Risk free rate |
| | So |
| | CAPM = Rrf + (beta*(retrurn on market - Rrf) |
| | |
| | Next calculate the WACC of the firm: |
| | WACC = (Weight Debt * Cost of Debt) + (Weight Equity * Cost of Equity ) |
| | and remember to calculate the cost of debt as Cost od debt*(1-Tax rate) |
| | |
| | |
| | 2) Calculate the cash flows for the new crystal jewelry project given the following assumptions: |
| | Initial investment outlay of $25 million, comprised of $20 million for machinery with $2 million for net working capital for metal inventory and $3 million for crystals |
| | Project and equipment life is 5 years |
| | Revenues are expected to increase $25 million annually |
| | Gross margin percentage is 40% (not including depreciation) |
| | Depreciation is computed at the straight-line rate for tax purposes |
| | Selling, general, and administrative expenses are 5% of sales |
| | Tax rate is 35% |
| | Compute net present value and internal rate of return of the project |
| | Year | 0 | 1 | 2 | 3 | 4 | 5 | Comments |
| | Revenues | | | | | | | 25m per year | | |
| | Gross Margin | | | | | | | 40% of revenues |
| | Sales & Admin | | | | | | | 5% of revenues |
| | Depreciation | | | | | | | 20 million over 5 years |
| | NWC Increase | | | | | | | 5 million out year 0 |
| | NWC Recovery | | | | | | | 5 million recovered end of project |
| | Capital Expenditures | | | | | | | 20 Million |
| | FCF | | | | | | | FCF=((Gross Margin-Sales&Admin)*(1-tax rate))+(Depreciation*tax rate)-NWC Increase - Capex + NWC recovery at end of project |
| | | | |
| | Tax | 35% | | |
| | Discount Rate | | Wacc as found in part A |
| | NPV | Use NPV Formula | = CFo + (NPV(WACC,FCF1,FCF2,FCF3,FCF4,FCF5) | | | or =C56+NPV(C59,D56:H56) | | |
| | IRR | Use IRR formula =IRR(Cfo:Cf5) | | | | or = IRR(C56:H56) | | |
| | 3) Calculate the cash flows for the new crystal jewelry project given the same assumptions in part 2 but considering a 3 year option |
| | Year | 0 | 1 | 2 | 3 | | | Comments |
| | Revenues | | | | | | | 25m per year |
| | Gross Margin | | | | | | | 40% of revenues |
| | Sales & Admin | | | | | | | 5% of revenues |
| | Depreciation | | | | | | | 20 million over 3 years |
| | NWC Increase | | | | | | | 5 million out year 0 |
| | NWC Recovery | | | | | | | 5 million recovered end of project |
| | Capital Expenditures | | | | | | | 20 Million |
| | FCF | | | | | | | FCF=((Gross Margin-Sales&Admin)*(1-tax rate))+(Depreciation*tax rate)-NWC Increase - Capex + NWC recovery at end of project |
| | | | |
| | Tax | 35% | | |
| | Discount Rate | | Wacc as found in part A |
| | NPV | Use NPV Formula | = CFo + (NPV(WACC,FCF1,FCF2,FCF3) | | | or =C81+NPV(C59,D78:F78) |
| | IRR | Use IRR formula =IRR(Cfo:Cf5) | | | | or = IRR(C78:F78) |
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felicia__freds_wacc.xlsx
