23. A firm is deciding on a new project. Use the following information for the p
ID: 2803507 • Letter: 2
Question
23. A firm is deciding on a new project. Use the following information for the project evaluation and analysis - The initial costs are $900,000 for fixed assets. The fixed assets will be depreciated straigh line to a zero book value over the 3-year life of the project. The fixed assets have an estimated salvage value of $60,000 at the end of the project. The project also requires an additional $200,000 for net working capital. All of the net working capital will be recouped at the end of the 3 years. The project is expected to generate sales of $2,000,000 (2,000 units at a sales price of $1,000/unit), incur total costs of $1,500,000 per year (comprised of variable cost of S500 per unit and fixed costs of $500,000). - The firm's marginal tax rate is 40 percent. - The company has 50,000 shares of common stock outstanding at a market price of $25 a - There are 1,000 bonds outstanding which mature in 13 years, have a face value per bond of -The target capital structure is 50% debt and 50% equity. share. The stocks have a beta of 1.5. The risk free rate is 1%, and the market risk premium is 10%. $1,000, and are currently quoted at $1,250 each. The bonds have a coupon rate of 10 percent. a) What is the Operating Cash Flow for each year of the project? b) What is the after-tax salvage value at the end of this project?Explanation / Answer
initial investment
900000
investment in working capital
200000
total cash outflow
1100000
a
operating cash flow
year
sales
less total cost
less depreciation
operating profit
less tax
after tax profit
add depreciation
operating cash flow
1
2000000
1500000
300000
200000
80000
120000
300000
420000
2
2000000
1500000
300000
200000
80000
120000
300000
420000
3
2000000
1500000
300000
200000
80000
120000
300000
420000
cash flow during year 3
operating cash flow+salavage value after tax+working capital
420000+200000+36000
656000
b
after tax salvage vale
book value of machine
0
salvage value of machine
60000
after tax net proceeds from salvage value
60000*(1-.4)
36000
g
cost of equity
risk free rate+(market premium)*beta
1+(10)*1.5
16
h
cost of debt
interest+(par value-market value)/years to maturity / (face value+market value)/2
100+(1000-1250)/13 / (1000+1250)/2
80.769/1125
7.18%
after tax cost of debt
7.18*(1-.4)
4.308
WACC
weight
cost of capital
weight*cost
debt
0.5
4.308
2.154
common stock
0.5
16
8
weighted average cost of capital
10.154
I
Net present value
Year
cash flow
present value of cash flow at 10.15% = cash flow/(1+r)^n
0
-1100000
-1100000
1
420000
381298.2
2
420000
346162.7
3
656000
490851.7
net present value
sum of present value of cash flow
118312.7
J
IRR
Year
cash flow
0
-1100000
1
420000
2
420000
3
656000
IRR =using irr function in ms excel spreadsheet =irr(-1100000,420000,420000,656000)
15.72%
K
Project should be accepted as its IRR is greater than weighted average cost of capital and NPV is positive
initial investment
900000
investment in working capital
200000
total cash outflow
1100000
a
operating cash flow
year
sales
less total cost
less depreciation
operating profit
less tax
after tax profit
add depreciation
operating cash flow
1
2000000
1500000
300000
200000
80000
120000
300000
420000
2
2000000
1500000
300000
200000
80000
120000
300000
420000
3
2000000
1500000
300000
200000
80000
120000
300000
420000
cash flow during year 3
operating cash flow+salavage value after tax+working capital
420000+200000+36000
656000
b
after tax salvage vale
book value of machine
0
salvage value of machine
60000
after tax net proceeds from salvage value
60000*(1-.4)
36000
g
cost of equity
risk free rate+(market premium)*beta
1+(10)*1.5
16
h
cost of debt
interest+(par value-market value)/years to maturity / (face value+market value)/2
100+(1000-1250)/13 / (1000+1250)/2
80.769/1125
7.18%
after tax cost of debt
7.18*(1-.4)
4.308
WACC
weight
cost of capital
weight*cost
debt
0.5
4.308
2.154
common stock
0.5
16
8
weighted average cost of capital
10.154
I
Net present value
Year
cash flow
present value of cash flow at 10.15% = cash flow/(1+r)^n
0
-1100000
-1100000
1
420000
381298.2
2
420000
346162.7
3
656000
490851.7
net present value
sum of present value of cash flow
118312.7
J
IRR
Year
cash flow
0
-1100000
1
420000
2
420000
3
656000
IRR =using irr function in ms excel spreadsheet =irr(-1100000,420000,420000,656000)
15.72%
K
Project should be accepted as its IRR is greater than weighted average cost of capital and NPV is positive
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