Question

Capital Budgeting Project

Instructions: This project requires you to apply the conceptsand methods learned in the course. This is an individualproject.

Assignment: You are interested in proposing a new venture to themanagement of your company. Pertinent financial information isgiven below.

Balance Sheet Data

Cash

5,000,000

Accounts Payable and Accruals

13,000,000

Accounts Receivable

24,000,000

Notes Payable

43,000,000

Inventories

39,000,000

Long-Term Debt

52,000,000

Preferred Stock

9,000,000

Net Fixed Assets

125,000,000

Common Equity

76,000,000

Total Assets

193,000,000

Total Liabilities &

Owners’ Equity

193,000,000

Last year’s sales were $170,000,000. The company has 61,50030-year bonds outstanding, with 15 years until maturity. The bondscarry a 9 percent semi-annual coupon, and are currently selling for$975.00. You also have 100,000 shares of perpetual preferred stockoutstanding, which pays a dividend of $8.00 per share. The currentmarket price is $97.00. The company has 6.55 million shares ofcommon stock outstanding with a current price of $18.00 per share.The stock exhibits a constant growth rate of 8.2 percent. The lastdividend (D0) was $0.97 per share.

Your firm does not use notes payable for long-termfinancing.

Your firm’s federal + state marginal tax rate is 31%.

The firm has the following investment opportunities currentlyavailable in addition to the venture that you are proposing:

Project

Cost

IRR

A

18,000,000

22%

B

25,000,000

18%

C

17,000,000

14%

D

32,000,000

11%

E

15,000,000

8%

All projects, including Project I, are assumed to be of averagerisk. Your venture would consist of a new product introduction (Youshould label your venture as Project I, for “introduction”). Youestimate that your product will have a six-year life span, and theequipment used to manufacture the project falls into the MACRS5-year class. The resulting MACRS depreciation percentages foryears 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and6%. Your venture would require a capital investment of $18,200,000in equipment, plus $1,100,000 in installation costs. The venturewould also result in an increase in accounts receivable andinventories of $3,000,000. At the end of the six-year life span ofthe venture, you estimate that the equipment could be sold at a$5,100,000 salvage value. Your venture would incur fixed costs of$1,350,000 per year, while the variable costs of the venture wouldequal 28 percent of revenues. You are projecting that revenuesgenerated by the project would equal $8,100,000 in year 1,$15,400,000 in year 2, $16,000,000 in year 3, $16,700,000 in year4, $11,000,000 in year 5, and $7,000,000 in year 6.

The following list of steps provides a structure that you shoulduse in analyzing your new venture. Note: Carry all finalcalculations to two decimal places.

1. Find the costs of the individual capital components (15points):

a. long-term debt

b. preferred stock

c. retained earnings (use DCF approach)

2. Determine the weighted average cost of capital. (5points)

3. Compute the Year 0 investment for Project I. (5 points)

4. Compute the annual operating cash flows for years 1-6 of theproject. (20 points)

5. Compute the non-operating (terminal) cash flow at the end ofyear 6. (10 points)

6. Draw a timeline that summarizes all of the cash flows foryour venture. (5 points)

7. Compute the IRR, payback, and NPV for Project I. (20points)

8. Prepare a report for the firm’s CEO indicating which projectsshould be accepted and why.

9. Conclude the project with your reflections on what you havelearned from this course and how it has affected your view of yourown job and career.

NEED ASSISTANCE WITH 3-8