BeautyHome is a furniture manufacturing company and it has 40% equity and 60% debt. Its cost of equity is 8% and cost of debt is 5%. Corporate tax rate is 40%.

a. If the firm changes its capital structure to replace all its debt with equity, what is the firms new cost of capital, what is its equity cost of capital?

After BeautyHome changes its capital structure, it is considering to open a new warehouse. With the new warehouse project, the company would increase annual production by 1,000 units with an average price at $500 per unit. Operating expense will be 75% of the revenue. To meet the increase in production capacity, the company will need to purchase a new equipment at the start of the project (considered at year 0) at a cost of $40,000. The equipment has a useful life of 5 years and the depreciation method is straight line method (with a salvage value of zero). The project is expected to last for 4 years and the company will sell the equipment for $9,000 at the end of year 4. In addition, the company will keep a net working capital of $5,000 starting from the end of year 1 and it will be reduced to $0 at the end of year 4. If the company does not open the new warehouse, it could lease the land to a third party and obtain an annual rental income of $80,000.

b. Calculate the free cash flow for each year, assuming all cash flows occur at the end of the year.

c. Assume BeautyHome maintains its current capital structure and the new warehouse has a similar level of risk with all other investments of BeautyHome. Use the Flow to Equity method to calculate the NPV of the new warehouse. (Hint: the current capital structure is the capital structure adopted in part a, i.e. with debt being replaced by equity.)