Reference no: EM131012179
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 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:
- 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?
- 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?
- 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.
- Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.
- 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?
- 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
|
- 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.
- 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.
|
Manufactures electric meters for sale
: Sino-electronics East-Africa Ltd manufactures electric meters for sale to its African and Middle-East customers. The product goes through three departments. The following information is available for the first department during June, 2014.
|
|
Bonds price increased or decrease
: A $1,000 par value bond with five years left to maturity pays an interest payment semiannually with a 5 percent coupon rate and is priced to have a 4.4 percent yield to maturity. If interest rates surprisingly increase by 0.5 percent, by how much wou..
|
|
Disadvantages of the capital asset pricing model
: The Capital Asset Pricing Model (CAPM) is a powerful analytical tool use for calculating the price of common stock. After reflecting on theory and application of the CAPM model and reviewing the prior work on the Constant Dividend Growth Model post a..
|
|
What is variability
: What is variability? What are the three types of variability? Why is variability valuable as a descriptive tool? Explain how to calculate and give an example for each type
|
|
Now calculate the irr for the project
: 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.
|
|
Calculate the fair present values of the bonds
: Calculate the fair present values of the following bonds, all of which pay interest semiannually, have a face value of $1,000, have 4 years remaining to maturity, and have a required rate of return of 14 percent. The bond has a 8.8 percent coupon rat..
|
|
Types of electronic calculators
: Numeric Corporation produces and markets two types of electronic calculators: Model 100 and Model 200. The following data were gathered for last month:
|
|
Something about how money grows over time
: Julie needs to pay a $5,000 tuition bill nine months from now. She has some money saved up that she could invest, but she is also considering a trip to Europe. She remembers reading something about how money grows over time, and she wonders if maybe ..
|
|
Agreement for sharing profits and losses
: Determine how the $ 110,000 net income would be divided under each of the following three independent assumptions as to the agreement for sharing profits and losses. Use schedules of the type illustrated in this chapter to show all steps in the di..
|