Reference no: EM13334813
You areinterested in proposing a new venture to management of your company. Financial information is below.
Assets:
Cash 2,000,000
Account Receivable 28,000,000
Inventories 42,000,000
Net Fixed Assets 133,000,000
Total Assets 205,000,000
Liabilities:
Accounts Payable & Accurals 18,000,000
Notes Payable 40,000,000
Long-term Debt 60,000,000
Preferred Stock 10,000,000
Common Equity 77,000,000
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% semi-annual coupon, and are currently selling for $874.78.
Also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. 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 current price of $14.00 per share. The stock exhibits a constant growth rate of 10%. Last dividend was $0.80. New stock could be sold with flotation costs, including market pressure of 15%.
The risk-free rate is currently 6%, and the rate of return on the stock market as a whole is 14%. Your stock's beta is 1.22.
Stockholders require a risk premium of 5% 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 doesn't 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.
The firm is currently using its asstes at capacity.
The firm's management requires a 2% adjustment to the cost of capital for risky projects.
Your firm has the following investment opportunities currently available in addition tot he venture 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 venture would consist of a new product introduction (project I), estimate that your product will a 6-year life span, and the equipment used to manufacture the project falls into the MACRO 5-class. Your venture would require a capital investment of $15,000,000 in equioment, plus $2,000,000 installation costs.
The venture would result in an increase in accounts receivable and inventories of $4,000,000. At the end of the 6-year life span, 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 varible costs of the venture would equal 30% of revenues.
Projectd revenues: year 1: $5,000,000; year 2: $10,000,000; year 3: $14,000,000; year 4: $16,000,000; year 5: $12,000,000; year 6: $8,000,000.
1. Find the costs of the individual capital components of:
A. long-term debt
B. preferred stock
C. retained earnings (avg. of CAPM, DCF, & bond yeild + risk premium approaches)
D. new common stock
2. Compute the value of the long-term elements of the capital structure, and determine the target percentages for the optimal capital structure.
3. Compute the retained earnings break point.
4. Draw the MCC schedule, including depreciation-generated funds in the schedule.
5. Compute the year 0 (zero) investment for project I.
6.Compute the annual operating cash flows for years 1 - 6 of the project.
7. Compute the additional non-operating cash flow at the end of year 6.
8. Draw a timeline that summarizes all of the cash flows for your venture.
9. Compute the IRR and payback period for project I.
10. Draw the IOS schedule, including project I along with projects A - E.
11. Determine your firms cost of capital.
12. Indicate which projects should be accepted based on your MCC and IOS schedules and why.
13. Compute the NPV for project I at the risk-adjusted cost of capital for the project. Should management adopt this project based on analysis? Explain. Would your answer be different if the project were determined to be of average risk?