Question
5. Find the Weighted Average Cost of Capital for Tasty Ltd. Tasty Ltd. operates a very successful chain of yogurt and coffee shops spread across
5. Find the Weighted Average Cost of Capital for Tasty Ltd.
Tasty Ltd. operates a very successful chain of yogurt and coffee shops spread across the South Island of New Zealand and needs to raise funds for its planned expansion into the North Island. The firm's balance sheet at the close of 2015 appeared as follows.
Tasty Ltd.
Balance Sheet
as at 31 December 2015
| $000 |
|
| $000 |
Cash | 2,010 |
|
|
|
Accounts Receivable | 4,580 |
|
|
|
Inventories | 1,540 |
| Long term Debt | 8,141 |
Net PPE | 32,575 |
| Common Equity | 32,564 |
Total Assets | 40,705 |
| Total Debt and Equity | 40,705 |
|
|
|
|
|
At present there are 1,000 shares of stock outstanding which are selling for $75 per share. Therefore, the market value of the common stock is $75,000. The debt is selling at its par value so is worth $8141. (Hint: The most correct way of doing this is to use market value weights. However, in ACCT102, you will be given credit for using book value weights.)
The firm has a tax rate of 35%. The market requires a return of 18 percent on the common stock and a yield to maturity of 8 percent.
6. This is a summary - putting it all together - problem.
Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $120,000 for a marketing survey to determine the viability of this product. It is felt that Potato Pet will generate sales of $525,000 per year. The fixed costs associated with this will be $178,000 per year and the variable costs will amount to 20% of sales. The equipment necessary for production of the Potato Pets will cost $540,000 and will be depreciated to zero using straight-line depreciation over the four years of the product life (as with all fads, it is felt the sales will end quickly). Pappy's marginal tax rate is 40%.
Equity (Stock) in Pappy's Potato has a Beta of 1.21. The market return is expected to be 15 percent and the risk-free rate is 8 percent. They use $.50 of debt for every $1 of equity which means they have a Debt/Assets ratio of .333. Their debt costs them 10% per year.
a. Draw a timeline for this project.
b. What is the annual operating cash flow for this project?
c. What is the initial cash flow for this project?
d. What is the WACC for this project?
e. What is the NPV of this project?
f. Should Pappy's Potato proceed with this project? Why or why not?
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