calculate cost of capital. cost of equity, cost of debt, weighted average cost of capital.
Automated Paving Stone Installer (APSI) Projections A new factory is needed to manufacture the APSI. The facility can produce up to 250 machines each year over the product's 15-year life. A parcel of land worth CAD 450,000 will be purchased, and a building constructed for CAD 1,750,000. Equipment costing CAD 3,550,000 is also be required. At the end of the project's life, it is estimated the land can be sold for CAD 770,000, while the building will have a residual value of CAD 850,000 and the equipment's residual value will be negligible. Building and equipment costs are subject to CCA rates of 4.0% and 20.0% respectfully. An investment of CAD 350,000 in net working capital is needed to support production that will be liquidated at the end of the product's life. APSI sales are forecasted to be 100 units in the first year, 200 in the second year, and then reach factory capacity of 250 units in the third year. The product's list price is CAD 350,000 and its unit cost is CAD 338,500, which includes direct materials, direct labour and factory overhead. Incremental selling and administration costs will be CAD 1,570,000. Existing corporate overhead of CAD 230,000 per year will be allocated to the product as per company policy. Factory equipment will be overhauled at a cost of CAD 1,500,000 at the end of year 8. Discount Rate In the past, MDFA used a corporate cost of capital to evaluate the feasibility of its new product proposals. Denison felt this rate was inaccurate as it reflected the weighted average cost of capital of the three MDFA divisions. The Ventilation Division likely has a higher cost of capital since its products are sold primarily to private sector companies with greater exposure to the business cycle. In comparison, the Surfaces Division likely has a lower cost of capital as it sells its products primarily to city and municipal governments with relatively stable tax revenues and Page 2 public works budgets. To be more precise, Denison decided to use divisional costs of capital to evaluate each project To determine the cost of capital for the Ventilation Division, Denison collected information on five public companies in the industry: Company Rapid Flow Environmental Systems Clean Air CircuVent Pure All Beta 1.43 1.25 1.37 1.42 1.29 Treasury Spread 4.1296 3.919 4.0396 4.08% 4.0296 For the surfaces Division, MDFA only has one publicly-traded North American company for comparison. Dura Surface Ltd. has been in existence for 30 years selling road and sidewalk surfacing machinery Exhibit 1 provides share prices for Dura Surface and national stock index values for the last five years. Dura Surface issues bonds to finance its operations, which currently trade at 101.11 and have a coupon rate of 5,31% and a term of 15 years Company Rapid Flow Environmental Systems Clean Air CircuVent Pure Air Beta 1.43 1.25 137 1.42 1.29 Treasury Spread 4.12% 3.91% 4.03% 4.08% 4.02% For the Surfaces Division, MDFA only has one publicly-traded North American company for comparison. Dura Surface Ltd. has been in existence for 30 years selling road and sidewalk surfacing machinery. Exhibit 1 provides share prices for Dura Surface and national stock index values for the last five years. Dura Surface issues bonds to finance its operations, which currently trade at 101.11 and have a coupon rate of 5.31% and a term of 15 years. Due to its strong financial position, MDFA is able to raise new capital inexpensively. The cost of issuing new equity is 5.0% and the cost of raising debt is 1.5%. Company policy is not to include issuance costs in the costs of capital, but to show it as a cash outflow in all NPV analyses. Retained earnings are used instead of new equity to fund growth to avoid control problems. The interest rate on the 20-year Government of Canada bond is currently 4.0% and the market risk premium is 5.5%. MDFA has a marginal tax rate of 25.0% and a long-term debt to total capitalization ratio of 35.0% which approximates the company's target capital structure. I Monthly Stock Index 1 2 3 4 6003.56 6037.33 6154.88 6234.33 6450.67 6340.77 6120.88 5807.33 5783.78 5845.44 5965.44 5927.03 5803.34 6034.33 6100.93 6378.45 6456.33 6409.37 6543.55 8698.33 6703.87 6684.34 6834.95 6699.44 6584.50 6593.22 6534.56 6667.98 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 Dura Surface Share Price 60.21 61.31 62.66 63.38 63.21 61.88 58.27 54.54 53.54 55.65 57.66 55.33 54.87 57.38 60.38 63.37 65.08 64.30 67.39 70.74 74.32 69.30 72.77 72.64 64.58 65.38 63.76 66.31 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 6490.88 6389.22 6289.78 6305.53 6310.76 6450.33 6477.88 6485.94 6432.94 6600.00 6734.55 7321.34 7454.34 7645.48 7903.33 8134.33 8234.33 8305.33 8300.87 8413.75 8500.33 8700.34 8654.00 8778.30 8503.00 8876.33 8903.33 9034.44 8953.33 8957.32 9003.78 8933.68 65.43 62.87 60.38 61.83 62.95 64.30 64.57 66.83 63.83 65.44 68.33 73.58 74.83 80.30 72.37 77.30 80.58 83.58 83.32 84.69 85.32 89.69 87.32 90.64 87.32 93.65 92.43 93.43 92.55 95.53 94.33 93.58 48 49 50 51 52 53 54 55 56 57 58 59 60
