Problem#2 The Tomas School of Falconry is considering replacing a piece of equip
ID: 2805149 • Letter: P
Question
Problem#2
The Tomas School of Falconry is considering replacing a piece of equipment used in making falconry perches. The existing machine has 3 years useful life remaining. The machine had an original cost of $50,000, 3 years ago, and is projected to have a salvage value of $5,000 in 3 years time. The existing machine has a current market value of $30,000. The company has been depreciating the machine down to its salvage value using straight line depreciation. The new machine has a useful life of 3 years, will cost $75,000, and will be depreciated using the MACRS 3 year table (yr-1 33.33%, yr-2 44.44%, yr-3 14.82%, yr-4 7.41%). The new machine will have an expected salvage value of $8,000 in 3 years time. The new machine will save $40,000 a year in costs. There will be no change in Net Working Capital usage for the new machine versus the old machine. The company is in the 40% tax bracket. The Tomas School of Falconry has 12 million shares of stock outstanding with a current market price of $11.30. The stock’s beta is 2.3. The return on the S&P500 is expected to be 11%, while the return on 1 year Treasury bills is 2.2%. The company has $30 million in face value of debt outstanding. The debt has a price of 93’21. The bonds have a coupon rate of 7%, and pay coupons semi-annually. The bonds will mature in 25 years. Based on NPV should the School replace the existing machine? Calculate the CFFA,NPV,Cost of Equity, After-tax cost of Debt,Weight Equity and WACC.
Explanation / Answer
Cost of equity = 2.2% + 2.3(11%-2.2%)
= 22.44%
Cost of debt = (3.5+(100-93.21)/50) / (100+93.21)/2
= 7.52%
After tax cost of debt = 7.52%*0.6
= 4.52%
WACC
Cash flow table
cost Market value weight Weigheted cost Equity 0.22 $13,56,00,000 0.83 0.19 Debt 0.05 $2,79,63,000 0.17 0.01 $16,35,63,000 19.38%Related Questions
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