1. Determine the current weighted average cost of capital for CWC. 2. Determine the appropriate discount rate...
Question:
1. Determine the current weighted average cost of capital for CWC.
2. Determine the appropriate discount rate for the healthy bottled water project.
3. Should the firm undertake the healthy bottled water project? As part of your analysis, include sensitivity analysis for sales price, variable costs, fixed costs, and unit sales at ±10%, 20%, and 30% from the base case. Also perform an analysis of the following two scenarios:
a. Best case: Selling 2,500,000 units at a price of $1.24 per unit with variable production costs of $0.22 per unit.
b. Worst case: Selling 950,000 units at a price of $1.32 per unit, with variable production costs of $0.27 per unit.
Cascade Water Company (CWC) currently has 30,000,000 shares of common stock outstanding that trade at a price of $42 per share. CWC also has 500,000 bonds outstanding that currently trade at $923.38 each. CWC has no preferred stock outstanding and has an equity beta of 2.639. The risk-free rate is 3.5%, and the market is expected to return 12.52%. The firm€™s bonds have a 20-year life, a $1,000 par value, a 10% coupon rate and pay interest semi-annually.
CWC is considering adding to its product mix a €œhealthy€ bottled water geared toward children. The initial outlay for the project is expected to be $3,000,000, which will be depreciated using the straight-line method to a zero salvage value, and sales are expected to be 1,250,000 units per year at a price of $1.25 per unit. Variable costs are estimated to be $0.24 per unit, and fixed costs of the project are estimated at $200,000 per year. The project is expected to have a 3-year life and a terminal value (excluding the operating cash flows in year 3) of $500,000. CWC has a 34% marginal tax rate. For the purposes of this project, working capital effects will be ignored. Bottled water targeted at children is expected to have different risk characteristics from the firm€™s current products. Therefore, CWC has decided to use the €œpure play€ approach to evaluate this project. After researching the market, CWC managed to find two pure-play firms. The specifics for those two firms are:
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Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
Step by Step Answer:
1 of securities Price per security Total Market Value Weight Equity 30000000 4200 1260000000 7318 Debt 500000 92338 461690000 2682 Sum 1721690000 Thus the w d 2682 and the w e 7318 Using the CAPM we c...View the full answer
Introduction to Corporate Finance What Companies Do
ISBN: 978-1111222284
3rd edition
Authors: John Graham, Scott Smart
