Reference no: EM13306174
Q1:
| COMPUTE WEIGHTED AVERAGE COST OF CAPITAL |
enter data in blue-colored cells |
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| BASIC: |
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Formula |
Equation |
| COST OF DEBT: |
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| Coupon Rate |
0.00% |
given |
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| Marginal Tax Rate |
0.0% |
given |
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| Cost of Debt |
0.00% |
b5*(1-b6) |
k-d = I x (1-t) |
| weight of debt |
0% |
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d ÷ d+e |
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| COST OF EQUITY: |
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| Risk-Free Rate |
0.00% |
given |
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| Risk Premium |
0.00% |
given |
R-m - R-f |
| Beta |
0.00 |
given |
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| Cost of Equity |
0.00% |
b11+(b13*b12) |
k-e = R-f + [ß x (R-m - R-f)] |
| weight of equity |
100% |
1-b8 |
e ÷ d+e |
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| Weighted-Average Cost of Capital |
0.00% |
(b8*b7)+(b15*b14) |
(k-d x wt-d)+(k-e x wt-e) |
Page 75 in Cohen Finance Workbook displays a K-wacc calculation for a company.
Suppose that the inputs to that k-wacc calculation have changed.
The company's financial risk has increased, so its coupon rate is now 9%.
Its marginal tax rate increased to 30%.
To reduce financial risk, its 'target' weight of debt is reduced to 30%.
The risk-free rate on treasury bonds is now 2%.
The risk premium stays the same at 8%.
The beta, reflecting higher financial risk, rises to 1.5.
Recalculate k-wacc, using the template at the top of this page.
Explain the significance of the change in k-wacc to the capital budgeting analysis and recommendation. Use the box below:
Q2a - Explain how the table below works, i.e., what are the inputs, what are the outputs, and how are the inputs transformed into the outputs.
HINT: Examine the formulas in the cells.
| Change in Net Working Capital: |
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| Revenue |
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1000.0 |
1000.0 |
1000.0 |
1000.0 |
1000.0 |
| Cost of goods sold |
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22.0 |
22.0 |
22.0 |
22.0 |
22.0 |
| Receivables (enter days in Column B) |
30 |
82.2 |
82.2 |
82.2 |
82.2 |
82.2 |
| Inventory (enter days in Column B) |
50 |
3.0 |
3.0 |
3.0 |
3.0 |
3.0 |
| Payables (enter days in Column B) |
25 |
1.5 |
1.5 |
1.5 |
1.5 |
1.5 |
| Net working capital needs |
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83.7 |
83.7 |
83.7 |
83.7 |
83.7 |
| Liquidation of working capital |
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0.0 |
| Investment in working capital |
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83.7 |
0.0 |
0.0 |
0.0 |
0.0 |
Q2b - Row 43 changes compared to row 14 in Q2a. Explain how the investment in working capital changes (compared to the amount in Q2a) and why. Change in Net Working Capital:
| Revenue |
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1000.0 |
1100.0 |
1200.0 |
1300.0 |
1400.0 |
| Cost of goods sold |
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22.0 |
24.2 |
26.4 |
28.6 |
30.8 |
| Receivables (enter days in Column B) |
30 |
82.2 |
90.4 |
98.6 |
106.8 |
115.1 |
| Inventory (enter days in Column B) |
50 |
3.0 |
3.3 |
3.6 |
3.9 |
4.2 |
| Payables (enter days in Column B) |
25 |
1.5 |
1.7 |
1.8 |
2.0 |
2.1 |
| Net working capital needs |
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83.7 |
92.1 |
100.4 |
108.8 |
117.2 |
| Liquidation of working capital |
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0.0 |
| Investment in working capital |
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83.7 |
8.4 |
8.4 |
8.4 |
8.4 |
Q2c - B71 and B72 are changed from the number of days in Q2a and Q2b. Explain how the investment in working capital changes (compared to the amount in Q2b) and why.
| Change in Net Working Capital: |
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| Revenue |
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1000.0 |
1100.0 |
1200.0 |
1300.0 |
1400.0 |
| Cost of goods sold |
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22.0 |
24.2 |
26.4 |
28.6 |
30.8 |
| Receivables (enter days in Column B) |
60 |
164.4 |
180.8 |
197.3 |
213.7 |
230.1 |
| Inventory (enter days in Column B) |
100 |
6.0 |
6.6 |
7.2 |
7.8 |
8.4 |
| Payables (enter days in Column B) |
25 |
1.5 |
1.7 |
1.8 |
2.0 |
2.1 |
| Net working capital needs |
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168.9 |
185.8 |
202.7 |
219.6 |
236.5 |
| Liquidation of working capital |
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0.0 |
| Investment in working capital |
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168.9 |
16.9 |
16.9 |
16.9 |
16.9 |
Q3a
| Free cash flow: |
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| Operating cash flow |
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72.6 |
88.8 |
105.1 |
109.6 |
124.3 |
| Minus: Invesment in net working capital |
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12.3 |
3.1 |
3.1 |
0.9 |
1.8 |
| Minus: Investment in PPE (CapEx) |
300.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
| Plus: Salvage value |
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0.0 |
| Free cash flow |
-300.0 |
60.3 |
85.7 |
102.0 |
108.7 |
122.5 |
| Cumulative free cash flow |
-300.0 |
-239.7 |
-154.0 |
-52.0 |
56.7 |
179.2 |
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| Discount rate (K-wacc) |
10.9% |
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| Net Present Value (NPV) |
43.7 |
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| Profitability Index (PI) |
1.1 |
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| Internal Rate of Return (IRR) |
15.9% |
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| Payback Period (PP) |
inspection |
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Using the data below for the three projects, and the formulas you discerned in B12, B13, and B14, calculate NPV, PI, and IRR for the three projects, using two different k-wacc discount rates, 8% and 11%. The data for Projects A,B,C are arrayed vertically; they are the same as row 8 in the horizontal panel above.
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Project A |
Project B |
Project C |
| Initial Outlay |
-50,000 |
-100,000 |
-450,000 |
| Cash Inflows: Yr 1 |
10,000 |
25,000 |
200,000 |
| Yr 2 |
15,000 |
25,000 |
200,000 |
| Yr 3 |
20,000 |
25,000 |
200,000 |
| Yr 4 |
25,000 |
25,000 |
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| Yr 5 |
30,000 |
25,000 |
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Q3b Interpret the meaning of the calculations you made in Q3a.
Hint: Do you recommend accepting or rejecting the projects?
Hint: What is the impact on the decision metrics when k-wacc changes from 8% to 11%?
Hint: Do all three decision metrics lead to the same recommendation?