Capital Budgeting Project

Instructions: This project requires you to apply the concepts and methods learned in the course. This is an individual project.

Assignment: You are interested in proposing a new venture to the management of your company. Pertinent financial information is given below.

Balance Sheet Data

Cash

5,000,000

Accounts Payable and Accruals

13,000,000

Accounts Receivable

24,000,000

Notes Payable

43,000,000

Inventories

39,000,000

Long-Term Debt

52,000,000

Preferred Stock

9,000,000

Net Fixed Assets

125,000,000

Common Equity

76,000,000

Total Assets

193,000,000

Total Liabilities &

Owners Equity

193,000,000

Last years sales were $170,000,000. The company has 61,500 30-year bonds outstanding, with 15 years until maturity. The bonds carry a 9 percent semi-annual coupon, and are currently selling for $975.00. You also have 100,000 shares of perpetual preferred stock outstanding, which pays a dividend of $8.00 per share. The current market price is $97.00. The company has 6.55 million shares of common stock outstanding with a current price of $18.00 per share. The stock exhibits a constant growth rate of 8.2 percent. The last dividend (D0) was $0.97 per share.

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

Your firms federal + state marginal tax rate is 31%.

The firm has the following investment opportunities currently available in addition to the venture that you are proposing:

Project

Cost

IRR

A

18,000,000

22%

B

25,000,000

18%

C

17,000,000

14%

D

32,000,000

11%

E

15,000,000

8%

All projects, including Project I, are assumed to be of average risk. Your venture would consist of a new product introduction (You should label your venture as Project I, for introduction). You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 5-year class. The resulting MACRS depreciation percentages for years 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and 6%. Your venture would require a capital investment of $18,200,000 in equipment, plus $1,100,000 in installation costs. The venture would also result in an increase in accounts receivable and inventories of $3,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $5,100,000 salvage value. Your venture would incur fixed costs of $1,350,000 per year, while the variable costs of the venture would equal 28 percent of revenues. You are projecting that revenues generated by the project would equal $8,100,000 in year 1, $15,400,000 in year 2, $16,000,000 in year 3, $16,700,000 in year 4, $11,000,000 in year 5, and $7,000,000 in year 6.

The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.

1. Find the costs of the individual capital components (15 points):

a. long-term debt

b. preferred stock

c. retained earnings (use DCF approach)

2. Determine the weighted average cost of capital. (5 points)

3. Compute the Year 0 investment for Project I. (5 points)

4. Compute the annual operating cash flows for years 1-6 of the project. (20 points)

5. Compute the non-operating (terminal) cash flow at the end of year 6. (10 points)

6. Draw a timeline that summarizes all of the cash flows for your venture. (5 points)

7. Compute the IRR, payback, and NPV for Project I. (20 points)

8. Prepare a report for the firms CEO indicating which projects should be accepted and why.

9. Conclude the project with your reflections on what you have learned from this course and how it has affected your view of your own job and career.