Casper Corporation spent $100,000 on a marketing survey last year and the results show that there would be good demand for its intended new product that supports quick charging of mobile devices. Casper now plans to invest $2.5 million in fixed assets to manufacture and sell the new product over the next 4 years. For tax purposes, the invested assets are to be depreciated at a rate of 20% per year over a 5-year period. At the end of the 4-year project, the assets are expected to fetch a salvage value of $100,000 (before tax). Casper forecasts sales of the new product to be $5 million per year for the next 4 years. Annual operating costs excluding depreciation costs are expected to be 60% of annual sales. This project will also cause Casper's account receivables to increase by $1 million while its account payables are expected to increase by $200,000. Invested net operating working capital is expected to be fully recovered at the end of the project. However, this new project is expected to reduce the after-tax cash flows from Casper's existing products by $50,000 per year for the next 4 years. Annual interest cost during the life of the project is estimated to be $60,000 per year. Going forward, Casper aims to achieve a target capital structure of 60% debt and 40% common equity. Its current stock price is $25 (and the market is in equilibrium), with beta coefficient of 1.3, while its 6% annual-coupon bonds with par value of $1,000 and 8 years left to maturity are trading at $957.71. There are 5 million common stock and 9,000 bonds outstanding. Risk-free rate is 4% and required market return is 12%. Corporate tax rate is 30%. (a) What is the weighted average cost of capital of Casper Corporation? (4 marks) (b) What are the project's cash flows for Year 0 to Year 4? (12 marks) (c) What will be the estimated intrinsic value of Casper's shares if it undertakes the project? (4 marks) Casper Corporation spent $100,000 on a marketing survey last year and the results show that there would be good demand for its intended new product that supports quick charging of mobile devices. Casper now plans to invest $2.5 million in fixed assets to manufacture and sell the new product over the next 4 years. For tax purposes, the invested assets are to be depreciated at a rate of 20% per year over a 5-year period. At the end of the 4-year project, the assets are expected to fetch a salvage value of $100,000 (before tax). Casper forecasts sales of the new product to be $5 million per year for the next 4 years. Annual operating costs excluding depreciation costs are expected to be 60% of annual sales. This project will also cause Casper's account receivables to increase by $1 million while its account payables are expected to increase by $200,000. Invested net operating working capital is expected to be fully recovered at the end of the project. However, this new project is expected to reduce the after-tax cash flows from Casper's existing products by $50,000 per year for the next 4 years. Annual interest cost during the life of the project is estimated to be $60,000 per year. Going forward, Casper aims to achieve a target capital structure of 60% debt and 40% common equity. Its current stock price is $25 (and the market is in equilibrium), with beta coefficient of 1.3, while its 6% annual-coupon bonds with par value of $1,000 and 8 years left to maturity are trading at $957.71. There are 5 million common stock and 9,000 bonds outstanding. Risk-free rate is 4% and required market return is 12%. Corporate tax rate is 30%. (a) What is the weighted average cost of capital of Casper Corporation? (4 marks) (b) What are the project's cash flows for Year 0 to Year 4? (12 marks) (c) What will be the estimated intrinsic value of Casper's shares if it undertakes the project? (4 marks)
