Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Case AAA Health, Inc. ( NYSE: A 3 H ) is evaluating a new product, a vitamin C / fish oil blended energy drink. As
Case
AAA Health, Inc. NYSE: AH is evaluating a new product, a vitamin Cfish oil blended energy
drink. As an assistant director of the capital budgeting division of AAA Health, you are
responsible for the evaluation of the proposed project. You collected the following information
about the project and the cost of capital. You should make an acceptreject recommendation to
the director of your division based on your evaluation.
Information about the Proposed Project
Initial investment and depreciation: The new drink would be produced in an unused building
owned by AAA Health which is fully depreciated. The new equipment required for the
project would cost $ plus an additional $ for shipping and installation. With
the new project, inventories would rise by $ and accounts payable would increase by
$ All of these costs would be incurred at t The machinery will be depreciated
under the Modified Accelerated Cost Recovery System MACRS as year property. The
depreciation rates are at t at t at t and at t
Project life and salvage value: AAA Health expects to run the project for four years. The
cash inflows are assumed to begin one year after the project is undertaken, or at t and to
continue to t At the end of the projects life t the equipment is expected to have a
salvage value of $ Also, the firm will recover the net working capital at the end of the
project life.
Sales and operating costs: Unit sales are expected to total bottles per year, and the
expected sale price is $ per bottle. Cash operating expenses for the project total operating
costs excluding depreciation are expected to amount to percent of sales revenue.
Tax rate: AAAs marginal tax rate is percent.
Information for the Cost of Capital Estimation
AAA Health has outstanding bonds with a annual coupon rate, years remaining until
maturity, and a face value of $ The bonds make semiannual coupon payments and
currently are trading in the market at a price of $
AH can issue preferred stock with an offering price of $ per share, an annual pershare
dividend of $ Flotation costs are equal to of the gross proceeds.
Tenyear Treasury bond yield ; the market risk premium ; the beta of AH
Target weight of capital: percent debt, percent preferred stock, and percent common
equity.
AH can undertake a new project without issuing new shares of common stock if the
required initial investment does not exceed $ If the initial investment is greater than
$ the firm should sell new common stock.
Assume there is no constraints for the capital budget.
Traditional payback period
a Calculate the traditional regular payback period for the project.
b If the firm is using only the regular payback method to make its capital budgeting
decision and the target cutoff period is years, should this firm undertake this project?
Why?
Discounted payback period
a Calculate the discounted payback period for the project.
b If the firm is using only the discounted payback method to make its capital budgeting
decision and the target cutoff period is years, should this firm undertake this project?
Why?
NPV
a Calculate the projects NPV
b Based on the results of your NPV analysis, should the firm accept the project? Why?
IRR
a Calculate the projects IRR.
b Based on the results of your IRR analysis, should the firm accept the project? Why?
MIRR
a Calculate the projects MIRR.
b Based on the results of your MIRR analysis, should the firm accept the project? Why?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started