Assume NEWC has an investment opportunity(similar to the air bag opportunity in

Question

Assume NEWC has an investment opportunity(similar to the air bag opportunity in Other People's Money).The firm can spend a product that will be sold in packets or units of twenty.Assume the firm forescats this product to have the same profit margin(NI available to common stock/sales) as the other products in its product portofolio: ($8.52 per 1,000 individual units) and that margin WACC is 11% for this risk class project product. If the firm's sells the same number of units or packets every year for the next twenty years,how many packets (or units) must be sold each year for this to be zero-NPV project?

- Assume CF equals net income available to common stockholders plus depreciation.You may assume depreciation is 45,500 per year.Ignore taxes and ignore changes in net operating working capital,along with salvage value of the equipment used in the production process.You should also ignore any potential tax consequences of salvage value.You should use only the information provided and assume it is complete.Hint: CF must be an annuity(annuity of money) or there are hundreds of answers to this question.

Q4- If NEWC in question I above added some debt to its capital structure,would its WACC likely go down or up? Why? How would this impact the number or packets or units needed to be sold to be a zero NPV project?

(Please just answer Q4)

Explanation / Answer

If debt is added to the capital structure , the WACC of the company is likely to go down because the cost of debt is lower than the cost of equity due to the inherent benefits of investing in debt over equity such as lower risk, fixed rate of return irrespective of the revenues or profits or financial health of the company, preference in case of liquidation. Moreover, debt also provides tax shield which further lowers the WACC although in this case, taxes are supposed to be ignored and thus the tax benefits will also be ignored. However, generally the cost of debt is lower compared to equity and thus increasing the debt in the capital structure will reduce the WACC.

Since the WACC will go down, lower rate will be used to discount the future cash fllows. Thus, future cash flows when discounted to the present will have a higher value than earlier. Since the cash flows will have a higher present value than before, the cash flows should reduce for the project to have zero NPV. Thus,number of packets or units needed to be sold should decrease so as to decrease the cash flows so that the project can have zero NPV.

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