BALANCE SHEET Cash 2,000,000 Accounts Payable and Accruals 18,000,000 Accounts Receivable 28,000,000 Notes Payable 40,000,000 Inventories 42,000,000 Long-Term Debt 60,000,000 Preferred Stock 10,000,000 Net Fixed Assets 133,000,000 Common Equity 77,000,000 Total Assets 205,000,000 Total Claims 205,000,000 Market Values of Capital

The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 10 percent semi-annual coupon, and are currently selling for $874.78.

You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost.

The company has 5 million shares of common stock outstanding with a currently price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with flotation costs, including market pressure, of 15 percent.

The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stocks beta is 1.22.

Your firm does not use notes payable for long-term financing.

Your firms federal + state marginal tax rate is 40%.

Project A:

This project requires an initial investment of $20,000,000 in equipment which will cost an additional $3,000,000 to install. The firm will use the attached MACRS depreciation schedule to expense this equipment. Once the equipment is installed, the company will need to increase raw goods inventory by $5,000,000, but it will also see an increase in accounts payable for $1,500,000. With this investment, the project will last 6 years at which time the market value for the equipment will be $1,000,000.

The project will project a product with a sales price of $20.00 per unit and the variable cost per unit will be $10.00. It is estimated the sales volume for this project will be 700,000 in year 1, 1,000,000 in year 2, 650,000 in year 3, 700,000 in year 4, 650,000 in year 5 and 550,000 in year 6. The fixed costs would be $2,000,000 per year. Because this project is very close to current products sold by the business, management has expressed some favoritism towards this project and as allowed for a reduced rate of return of 2 percentage point below its current WACC as the valuation hurdle it must meet or surpass.

Project B:

This project requires an initial investment of $20,000,000 in equipment which will require additional expense of $1,000,000 to install in the current facility. Consistent with other projects, the equipment will be depreciated using the MACRS Investment Class schedule. Once installed, the firm will need to increase inventory by $6,000,000. The project will last 6 years, but at the end of that period, the equipment will have no salvage value.

During the operational period of this project, the product produced will sell for $6.50 per unit. The costs related to this product will be $4.00 per unit in variable cost and the fixed costs each year will be $1,000,000. Management has estimated that the sales volume for this project will be 3,500,000 in year 1, 4,000,000 in year 2, 4,250,000 in year 3, 4,500,000 in year 4, 4,300,000 in year 5, and 4,200,000 in year 6. Since the project has been brought under consideration through the normal channels, a discount rate equal to the WACC should be used in the project valuation.

Project C:

The project is outside of the normal products sold of the firm. The project is a reconsideration of a project proposed two years ago by a former manager. At that time a marketing study costing $200,000 was done; however, the project was not undertaken. Now the firm needs to consider if this project is worth the firms capital investment dollars. This project would require investment in equipment of $20,000,000 with an additional cost of $5,000,000 in installation fees. The project will be considered under a 6 year project cycle, but would be depreciated under the 5 year MACRS schedule. At the end of the project, management estimates that the equipment could be sold at a market value of $5,000,000. This project also creates a need to increase raw goods inventory by $6,000,000.

During the operational cycle of this project, the product would have a sales price of $90.00 per unit. Costs associated with this project would be $65.00 in variable cost per unit and a fixed cost per year of $5,000,000. Management estimates that the sales volume would be 500,000 units in year 1, 600,000 units in year 2, 700,000 units in year 3, 800,000 units in year 4, 800,000 units in year 5, and 600,000 units in year 6. Because management is uneasy with undertaking a project so far outside of its normal product portfolio, it is imposing a 3 percentage point premium above the WACC as the required rate of return on the project.

Modified Accelerated Cost Recovery System (MACRS)
Ownership Year		5-Year Investment Class Depreciation Schedule
1		20%
2		32%
3		19%
4		12%
5		11%
6		6%
		Total = 100%

Question:

Evaluate each project according to the following valuation methods:

a. Net Present Value of Discounted Cash Flow

b. Internal Rate of Return

c. Payback Period

d. Profitability Index