Reference no: EM131173436
Assignment 1: LASA # 2-Capital Budgeting Techniques
As a financial consultant, you have contracted with Wheel Industries to evaluate their procedures involving the evaluation of long term investment opportunities. You have agreed to provide a detailed report illustrating the use of several techniques for evaluating capital projects including the weighted average cost of capital to the firm, the anticipated cash flows for the projects, and the methods used for project selection. In addition, you have been asked to evaluate two projects, incorporating risk into the calculations.
You have also agreed to provide an 8-10 page report, in good form, with detailed explanation of your methodology, findings, and recommendations.
Company Information
Wheel Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35%.
Required:
1. Wheel has just paid a dividend of $2.50 per share. The dividends are expected to grow at a constant rate of six percent per year forever. If the stock is currently selling for $50 per share with a 10% flotation cost, what is the cost of new equity for the firm? What are the advantages and disadvantages of using this type of financing for the firm?
2. The firm is considering using debt in its capital structure. If the market rate of 5% is appropriate for debt of this kind, what is the after tax cost of debt for the company? What are the advantages and disadvantages of using this type of financing for the firm?
3. The firm has decided on a capital structure consisting of 30% debt and 70% new common stock. Calculate the WACC and explain how it is used in the capital budgeting process.
4. Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.
5. If the discount rate were 6 percent calculate the NPV of the project. Is this an economically acceptable project to undertake? Why or why not?
6. Now calculate the IRR for the project. Is this an acceptable project? Why or why not? Is there a conflict between your answer to part C? Explain why or why not?
Wheel has two other possible investment opportunities, which are mutually exclusive, and independent of Investment A above. Both investments will cost $120,000 and have a life of 6 years. The after tax cash flows are expected to be the same over the six year life for both projects, and the probabilities for each year's after tax cash flow is given in the table below.
|
Investment B
|
|
Investment C
|
|
Probability
|
After Tax
Cash Flow
|
|
Probability
|
After Tax
Cash Flow
|
|
0.25
|
$20,000
|
|
0.30
|
$22,000
|
|
0.50
|
32,000
|
|
0.50
|
40,000
|
|
0.25
|
40,000
|
|
0.20
|
50,000
|
1. What is the expected value of each project's annual after tax cash flow? Justify your answers and identify any conflicts between the IRR and the NPV and explain why these conflicts may occur.
2. Assuming that the appropriate discount rate for projects of this risk level is 8%, what is the risk-adjusted NPV for each project? Which project, if either, should be selected? Justify your conclusions.
|
What is the probability that the sibling is male
: The king has only one sibling. What is the probability that the sibling is male? Assume that every birth results in a boy with probability 1/2, independent of other births. Be careful to state any additional assumptions you have to make in order t..
|
|
Relaxing aromatherapy treatment
: Andrea’s Day Spa began to offer a relaxing aromatherapy treatment. The firm asks you how much to charge to maximize profits. The demand curve for the treatments is given by the first two columns. The total costs are given in the third column. For eac..
|
|
Description of the status of the plan
: Description of the status of the plan. Description of the strengths and weaknesses of the existing plan. Justify your answers. Recommended modifications to improve the current plan.
|
|
How budgeting was incorporated to achieve the companys goals
: Explain how budgeting was incorporated to achieve the company's overall goals and objectives. Reflect on whether or not the budgets were effectively applied and whether your experience was positive or negative.
|
|
Capital budgeting techniques
: As a financial consultant, you have contracted with Wheel Industries to evaluate their procedures involving the evaluation of long term investment opportunities. You have agreed to provide a detailed report illustrating the use of several techniq..
|
|
Consortia in the implementation of health programs
: Involvement of community coalitions and consortia in the implementation of health programs has become widespread. What would be possible and appropriate measures or indicators of having implemented community coalitions or consortia as part of the pro..
|
|
Explain the balance sheet and income statement of company
: Analyze the balance sheet and income statement of the company that you have selected, and outline your method for evidence collection which should include, but not be limited to, the type of evidence to collect and the manner.
|
|
How much of farmers sales will be included as apples in GDP
: A farmer sells $25,000 worth of apples to individuals who take them home to eat, $50,000 worth of apples to a company that uses them all to produce cider, and $75,000 worth of apples to a grocery store that will sell them to househoulds. How much of ..
|
|
Risk-free rate would affect the capital market line
: Briefly discuss and explain how a change in the risk-free rate would affect the capital market line, and subsequently affect the security market line
|