Cascade water Company (CWC) currently has 30,000,000 shares of common stock outs
ID: 2629888 • Letter: C
Question
Cascade water Company (CWC) currently has 30,000,000 shares of common stock outstanding that trade at a price of $42 per share. CWC also has 500,000 bonds outstanding that currently trade at $023.38 each. CWC has no preferred stock outstanding nad has an equity bets of 2.639. The risk-free rate is 3.5%, and the market is expected to return 12.52%. The firm's bonds have a 20 year life, a $1,000 per value, a 10% coupon rate, and pay interest semiannually. CWC is considering adding to its product mix a healthy bottled water geared toward children. The initial outlay for the project is expected to be $3,000,000, which will be depreciated using the straight-line mthod to a zero salvage value, and sales are expected to be 1,250,000 units per year at a price of $1.25 per unit. Variable costs are estimated to be $0.24 per unit, and fixed costs of the project are estimated at $200,000 per year. The project is expected to have a 3-year life and a terminal value (excluding the operating cash flows in year 3) of $500,000. CWC has a 34% tax rate. For the purposes of this project, working capital effects will be ignored. Bottled water targeted at child is expected to have a different risk characteristics from the firms' current products. Therefore, CWC has decided to use the "pure play" approach to evalue this project. After researching the market CWC managed to find two pure play firms. the specifics for those two firms are
Should the firm undertake the healthy bottled water project? As part of your analysis, include a sensitivity analysis for sales price, variable costs, fixed costs, and unit sales at plus or minus 10%, 20%, and 30% from the base case. Also perform an analysis of the following two scenarios:
a. best case: selling 2,500,000 units at a price $1.24 per unit, with variable production costs of $0.22 per unit
b. worst case: selling 950,000 units at a price of $1.32 per unit, with variable production costs of $0.27 per unit
Please show work
Firm Equity Beta D/E Tax Rate Fruity Water 1.72 0.43 34% Ladybug Drinks 1.84 0.35 36%Explanation / Answer
A company has different sources of finance, namely common stock, retained earnings, preferred stock and debt. Weighted average cost of capital (WACC) is the average after tax cost of all the sources. It is calculated by multiplying the cost of each source of finance by the relevant weight and summing the products up. Formula For a company which has two sources of finance, namely equity and debt, WACC is calculated using the following formula: Cost of equity is calculated using different models for example dividend growth model and capital asset pricing model. Cost of debt is based on the yield to maturity of the relevant instruments. If no yield to maturity can be calculated we can base the estimate on the instrument's current yield, etc. The weights are based on the target market values of the relevant components. But if no market values are available we base the weights on book values. Example Company ? has a 1 million shares of common stock currently trading at $30 per share. Current risk free rate is 4%, market risk premium is 8% and the company has a beta of 1.2. It also has 10,000 bonds with of $1,000 pare paying 10% coupon annually maturing in 20 years currently trading at $900. The company's tax rate is 35%. Calculate the weighted average cost of capital. Solution: First we need to calculate the weights of debt and equity. Market Value of Equity = 1,000,000
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