4.You are examining the viability of a capital investment that your firm is interested in. The project will require an initial investment of $500,000 and the projected revenues are $400,000 a year for 5 years. The projected cost-of-goods-sold is 40% of revenues and the tax rate is 40%. The initial investment is primarily in plant and equipment and can be depreciated straight-line over 5 years (the salvage value is zero). The project makes use of other resources that your firm already owns:

Two employees of the firm, each with a salary of $40,000 a year, who are currently employed by another division will be transferred to this project. The other division has no alternative use for them, but they are covered by a union contract which will prevent them from being fired for 3 years (during which they would be paid their current salary).

The project will use excess capacity in the current packaging plant. While this excess capacity has no alternative use now, it is estimated that the firm will have to invest $ 250,000 in a new packaging plant in year 4 as a consequence of this project using up excess capacity (instead of year 8 as originally planned).

The project will use a van currently owned by the firm. While the van is not currently being used, it can be rented out for $ 3000 a year for 5 years. The book value of the van is $10,000 and it is being depreciated straight line (with 5 years remaining for depreciation).

The discount rate to be used for this project is 10%.

a. What, if any, is the opportunity cost associated with using the two employees from another division?

b. What, if any, is the opportunity cost associated with the use of excess capacity of the packaging plant?

c. What, if any, is the opportunity cost associated with the use of the van?

d. What is the after-tax operating cashflow each year on this project?

e. What is the net present value of this project?

5.You have been asked to estimate the cost of capital for Lemur Enterprises, a company with a significant debt load, and a depressed stock price. You have the following information: The company has a book value of equity of $1 billion. There are 150 million shares, trading at $4/share. The unlevered beta of other companies in the same business is 1.20. The company has bank loans outstanding of $1 billion, with 5 years left to maturity and interest expenses of $40 million a year. The company currently has a CCC bond rating and has a default spread of 7% over the risk-free rate.

The firm reported a net loss of -$15 million, but its operating income is expected to be $32 million next year.

The risk-free rate is 3%, the equity risk premium is 5% and the marginal tax rate for all companies is 25%.

Estimate the cost of capital for the company, for next year.