Question
a. Dairy Company has two major Divisions: Industrial Suppliers and Consumer products. As the Financial Controller of the company, you need to consider and evaluate
a.
Dairy Company has two major Divisions: Industrial Suppliers and Consumer products. As the Financial Controller of the company, you need to consider and evaluate all proposals from the two Divisions.
The Industrial Supplies Division has recently secured a contract from a major customer to supply goods to the customer for 6 years. The manager of the Division comes up with two different technologies to produce the goods. The cash flows estimation of the two alternatives is listed as follows:
Alternative 1:2 years life (in thousand dollars)
Year | 0 | 1 | 2 |
Net cash flow | -300 | 250 | 350 |
Alternative 2:3 years life (in thousand dollars)
Year | 0 | 1 | 2 | 3 |
Net cash flow | -400 | 200 | 300 | 300 |
The company's tax rate is 30% and the cost of capital is 12%.
Calculate the NPV of the two alternatives from the Industrial Supplies Division.
Should you base your choice of alternatives on the NPV calculated? Explain. If not, suggest another approach for your decision and determine which alternative to adopt for the Industrial Supplies Division.
b.
Rollins Corporation is estimating its WACC. Its target capital structure is 20% debt, 20% preferred stock, and 60% common equity. Its bonds have par value of $1,000, a 12% coupon, paid semi-annually, a current maturity of 10 years, and sell at par. The firm could sell $100 par preferred stock at $104 which pays a 13% annual dividend. Rollins' beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. The firm's marginal tax rate is 40%.
Determine the WACC of Rollins. Under what circumstances the weighted average cost of capital can be used for evaluating capital budgeting pojects?
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