Question
1. The Albeit Asitis Corporation is known for the high quality of its Snirfel Sprocket Inverters internationally. It has undertaken to expand recently and requires
1. The Albeit Asitis Corporation is known for the high quality of its Snirfel Sprocket Inverters internationally. It has undertaken to expand recently and requires your assistance in determining first the Weighted Average Cost of Capital, and the determination of a capital budget for the purchase of a new machine which is expected to last about seven years.
To determine the WACC, the following information is helpful:
The calculation is done based on total debt, short and long term, for which the company pays 9%, and the Tax Rate is 25%.
The company will determine the cost equity using the CAPM model, which is based on the following information:
Standard deviation of the market 5.00%
Standard deviation of Albeit - 7.00%
Covariance 43.75
T-bond rate 3 month - 3.00%
Expected Market return - 12.00%
The Balance Sheet looks like this:
Your first task:
- Calculate the Debt/Equity and working capital (current) ratios. What is your professional opinion, given that for the sector, the ratios are usually 3 and 1.2 respectively?
- Calculate the WACC of the firm and explain what it is used for. How would you tell the owners how this figure will help them?
The weighted average cost of capital (WACC) reflects the expected average future cost of funds over the long run.
2. The firm is planning on starting a new operation which will last for about seven years. The initial cash injection will be $35,000. The revenues for the seven years are expected to be:
1 | 2 | 3 | 4 | 5 | 6 | 7 |
13,000.00 | 14,000.00 | 17,000.00 | 18,000.00 | 20,000.00 | 25,000.00 | 20,000.00 |
The variable costs are 35%
The tax rate remains at 25%
Fixed costs are $2,500 per year
The company expects a recovery on concluding operations of $12,000. This amount is taxable.
Your second task:
You will need to use an Excel spread sheet for this. Please cut and paste the final answers to a Word document.
a) Work out a simplified capital budget using the above data
b) Determine the NPV using the WACC as determined in part 1.
c) Determine the IRR based on the capital budget you worked out.
Finally, what is your recommendation to the owner of this business regarding the project. Should he investigate it further, or should he abandon the idea? Why or why not?
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