Reference no: EM132816222

Scenario:

• Shantel Joshi , the CFO for the firm PSUWC Designer Jeans Company, LLC, woke up with a start at 4:00 am on 12/10/20, due to the phone ringing. It was the firms senior financial analyst, vacationing in Europe, calling with bad news. Shantel was supposed to present the project evaluation, at the end of the week, for the Board's proposal that they invest in new equipment which would enable them to add a new product line. Currently PSUWC has four successful products and they are considering selling a new Designer Jeans line.
• The staff of financial analysts had been working hard over the last few weeks collecting data and had prepared a model creating a financial forecast about the proposed project's viability.
• Disaster had struck on the night of 12/9/20 wherein malware all but wiped out the work of the analysts. Shantel needed to prepare an financial analysis of the project to present the Board with recommendations. All the staff had already left for their annual vacation and Shantel was working alone. Shantel quickly reached the office and managed to salvage what was left of the excel spreadsheet prepared for the presentation. What follows is some basic information that Shantel knew and was able to retrieve about the project.
• PSUWC's existing plant has excess capacity, in a fully depreciated building, to install and run the new equipment to produce the new Designer Jeans line. Due to relatively rapid advances in technology, the project was expected to be discontinued in four years.
• The new Designer Jeans was expected to sell for $ 118 per unit and had projected sales of 4500 units in the first year, with a projected (Most-Likely scenario) 23.0 % growth rate per year for subsequent years. A total investment of $ 968,000 for new equipment was required. The equipment had fixed maintenance contracts of $ 336,448 per year with a salvage value of $ 132,348 and variable costs were 7 % of revenues. Shantel also needed to consider both the Best-Case and Worst-Case scenarios in the analysis with growth rates of 33.00 % and 2.30 % respectively.The new equipment would be depreciated to zero using straight line depreciation. The new project required an increase in working capital of $ 155,280 and $ 21,739 of this increase would be offset with accounts payable.
• PSUWC currently has 850000 shares of stock outstanding at a current price of $ 76.00. Even though the company has outstanding stock, it is not publicly traded and therefore there is no publicly available financial information. However, after analysis management believes that its equity beta is 1.22.
• The company also has 94000 bonds outstanding, with a current price of $ 1,096.00. The bonds pay interest semi-annually at a coupon rate of 5.80 %. The bonds have a par value of $1,000 and will mature in 6 years. The average corporate tax rate was 38 %.
• Management believes the S&P 500 is a reasonable proxy for the market portfolio. Therefore, the cost of equity is calculated using the company's equity beta and the market risk premium based on the S&P 500 annual expected rate of return - Shantel would calculate the monthly expected market return using 5 years of past monthly price data available in the worksheet Marketdata. This would then be multiplied by 12 to estimate the annual expected rate. Shantel remembered that if the expected rate of return for the market was too low, too high, or negative, a forward looking rate of an historical average of about 9.5% would have to be used, as the calculated value for the current 5-year period may not be representative of the future. Shantel would consider a E(Rm) between 8-12% acceptable. Shantel would calculate the market risk premium: E(Rm) - Rf from the previous calculations using the risk-free rate data available in the worksheet Marketdata. Shantel noted that the risk-free rate was on an annual basis.
• Shantel needed to calculate the rate at which the project would have to be discounted to calculate the Net Present Value (NPV) of the proposed project based on the decision of raising capital and the current capital market environment. This discount rate, the WACC, would obviously influence the NPV and could affect the decision of whether to accept or reject the project. Thankfully, all the information needed to calculate this was available. Shantel needed to clearly show all the calculations and sources for all parameter estimates used in the calculation of the WACC (and ultimately the NPV).
• Gathering all the available information, Shantel got a large cup of extra strong coffee and sat down to work on the development of the Capital Budgeting project model. The correct recommendation to the board was critical to the future growth of the firm!

Problem 1: What is the Change in NWC?

Problem 2: What is the Marginal Tax Rate?

Problem 3: What is the Market Value of Equity?

Problem 4: What is the Market Value of Debt?

Problem 5: What is the Total Market Value?

Problem 6: What is the Weight of Equity?

Problem 7: What is the Weight of Debt?

Problem 8: What is the Cost of Equity (re)?

Problem 9: What is the Cost of Debt (rd)?

Problem 10: What is the After-Tax Cost of Debt?

Problem 11: What is the WACC?

Problem 12: What is the # of Shares Outstanding?

Problem 13: What is the # of Bonds Outstanding?

Problem 14: What is the PMT?

Problem 15: What is the Before tax YTM?

Problem 16: What is the Before tax YTM * 2?