A company is considering investing in an online book ordering and information service, which will be managed by 2 employees The following estimates relate to the costs of starting the service and the subsequent revenues from it The initial investment needed to start the service, including the installation of additional phone lines and computer equipment, will be $1,000,000 These investments are expected to have a life of 4 years with 0 salvage value The investments will be depreciated straight line over the four year life The revenues in the first year are expected to be $1500,000, growing 20 in year 2, and 10 in the two years following The salaries and other benefits for the employees are estimated to be $150,000 in year 1, and grow 10 a year for the following three years The cost of the books is assumed to be 0 60 of the revenues in each of the four years The non cash working capital, which includes the inventory of books needed for the service and the accounts receivable (associated with selling books on credit), is expected to amount to 10 of the revenues the investments in working capital have to be made at the beginning of each year At the end of year four, the entire working capital is salvaged at book value The tax rate on income is expected to be 40 For above project prepare the following Assume that the company would be funded using the same market debt to equity ratio as the book publishing industry Staying consistent, we will use the market debt to capital ratio of the sector to compute the cost of capital for the firm Cost of Equity 7 46 Pre tax cost of debt 4 05 After tax cost of debt 2 43 Debt to equity ratio 17 63 The ten year U S Treasury bond rate was 2 75 Tax rate for the firm is 40 We computed a cost of capital based on that assumption For this project we will use total beta of 1 6783 to measure the additional risk that the owner of business is exposed to because of his lack of diversification Required Find payback period for Main project

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Posted on Sep 09, 2024

A company is considering investing in an online book ordering and information service, which will be managed by 2 employees. The following estimates relate to

A company

is considering investing in an online book ordering and information service, which will be managed by 2 employees. The following estimates relate to the costs of starting the service and the subsequent revenues from it.

The initial investment needed to start the service, including the installation of additional phone lines and computer equipment, will be $1,000,000. These investments are expected to have a life of 4 years with 0 salvage value.
The investments will be depreciated straight line over the four-year life.
The revenues in the first year are expected to be $1500,000, growing 20% in year 2, and 10% in the two years following.
The salaries and other benefits for the employees are estimated to be $150,000 in year 1, and grow 10% a year for the following three years.
The cost of the books is assumed to be 0.60 of the revenues in each of the four years.
The non-cash working capital, which includes the inventory of books needed for the service and the accounts receivable (associated with selling books on credit), is expected to amount to 10% of the revenues; the investments in working capital have to be made at the beginning of each year.
At the end of year four, the entire working capital is salvaged at book value.
The tax rate on income is expected to be 40%.

For above project prepare the following :

Assume that the company would be funded using the same market debt-to-equity ratio as the book/publishing industry. Staying consistent, we will use the market debt-to-capital ratio of the sector to compute the cost of capital for the firm.

Cost of Equity : 7.46%

Pre-tax cost of debt : 4.05%

After tax cost of debt : 2.43%

Debt to equity ratio : 17.63%.

The ten-year U.S. Treasury bond rate was 2.75%.

Tax rate for the firm is 40%. We computed a cost of capital based on that assumption.

For this project we will use total beta of 1.6783 to measure the additional risk that the owner of business is exposed to because of his lack of diversification.

Required: Find payback period for Main project.