Comprehensive capital budgeting project A comprehensive capital budgeting projec
ID: 2756243 • Letter: C
Question
Comprehensive capital budgeting project
A comprehensive capital budgeting project is due the last week.
Assignment: You work for a firm that produces oil paintings of dead music and movie stars on black velvet. Here, here and here are samples of what your firm produces (pretty creepy really).
You are proposing a new venture, to branch out into animals and cartoon characters but this will require some new equipment and a capital outlay. Pertinent financial information is given below.
BALANCE SHEET
Cash
2,000,000
Accounts Payable and Accruals
18,000,000
Accounts Receivable
28,000,000
Notes Payable
40,000,000
Inventories
42,000,000
Long-Term Debt
60,000,000
Preferred Stock
10,000,000
Net Fixed Assets
133,000,000
Common Equity
77,000,000
Total Assets
205,000,000
Total Claims
205,000,000
· Last year’s sales were $225,000,000.
· The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent annual coupon, and are currently selling for $874.78.
· You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost.
· The company has 10 million shares of common stock outstanding with a currently price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with 15% flotation costs.
· The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22.
· Stockholders require a risk premium of 5 percent above the return on the firms bonds.
· The firm expects to have additional retained earnings of $10 million in the coming year, and expects depreciation expenses of $35 million.
· Your firm does not use notes payable for long-term financing.
· The firm considers its current market value capital structure to be optimal, and wishes to maintain that structure. (Hint: Examine the market value of the firm’s capital structure, rather than its book value.)
· The firm is currently using its assets at capacity.
· The firm’s management requires a 2 percent adjustment to the cost of capital for risky projects.
· Your firm’s federal + state marginal tax rate is 40%.
· Your firm’s dividend payout ratio is 50 percent, and net profit margin was 8.89 percent.
· The firm has the following investment opportunities currently available in addition to the expansion you are proposing:
Project
Cost
IRR
A
10,000,000
20%
B
20,000,000
18%
C
15,000,000
14%
D
30,000,000
12%
E
25,000,000
10%
Your expansion would consist of a new product introduction (You should label your venture as Project I, for “introduction”). You estimate that your product will have a six-year life span (after all how many people will really buy this stuff), and the equipment used to manufacture the project falls into the MACRS 5-year class. Your venture would require a capital investment of $15,000,000 in equipment, plus $2,000,000 in installation costs. The venture would also result in an increase in accounts receivable and inventories of $4,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $4,000,000 salvage value.
Your venture, which management considers fairly risky, would increase fixed costs by a constant $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $5,000,000 in year 1, $10,000,000 in year 2, $14,000,000 in year 3, $16,000,000 in year 4, $12,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture.
Note: Carry all final calculations to two decimal places.
Find the Cash Flow from the project:
3. Compute the Year 0 investment for Project I. (5 points)
4. Compute the annual operating cash flows for years 1-6 of the project. (30 points)
5. Compute the additional non-operating cash flow at the end of year 6. (5 points)
Cash
2,000,000
Accounts Payable and Accruals
18,000,000
Accounts Receivable
28,000,000
Notes Payable
40,000,000
Inventories
42,000,000
Long-Term Debt
60,000,000
Preferred Stock
10,000,000
Net Fixed Assets
133,000,000
Common Equity
77,000,000
Total Assets
205,000,000
Total Claims
205,000,000
Explanation / Answer
Question no 1 cost of equipment = 1500000 Installation cost 200000 Additions in working capital 4000000 Investment in project in Year 0 = 5700000 question No 2 Years Cash flow Variable cost fixed cost EBIT Depreciation Cash flow after dep Tax rate 40% cash flow after tax ADD dep operating cash flow 0 30% 40% 1 5000000 1500000 100000 3400000 260000 3140000 1256000 1884000 260000 2144000 2 10000000 3000000 200000 6800000 416000 6384000 2553600 3830400 416000 4246400 3 14000000 4200000 300000 9500000 249600 9250400 3700160 5550240 249600 5799840 4 16000000 4800000 400000 10800000 149760 10650240 4260096 6390144 149760 6539904 5 12000000 3600000 500000 7900000 149760 7750240 3100096 4650144 149760 4799904 6 8000000 2400000 600000 5000000 74880 4925120 1970048 2955072 74880 3029952 Question no 3 Non operating cash flow Year 6 cash flow from scrap value 4000000 amount realised from investment in additional working capital 4000000 Cash flow from non operating items= 8000000 depreciation cost of equipment = 1500000 Installation cost 200000 total cost of machine = 1700000 (scrap value) 400000 depreciable value 1300000 Annaul depreciation 1 20% 1300000 260000 2 32% 1300000 416000 3 19.20% 1300000 249600 4 11.52% 1300000 149760 5 11.52% 1300000 149760 6 5.76% 1300000 74880 1 1300000
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.