Full Case:

Answer Sheet (CapitalBudget)

MarketData

INSTRUCTIONS

NPV Profile

scenario: Shantel Joshi , the CFO for the firm PSUWC Designer Womens Tops Company, LLC, woke up with a start at 4:00 am on 4/28/23, due to the phone ringing. It was the firms senior financial analyst, vacationing in Europe, calling with bad news. Shantel was supposed to present the project evaluation, at the end of the week, for the Board's proposal that they invest in new equipment which would enable them to add a new product line. Currently PSUWC has four successful products and they are considering selling a new Designer Womens Tops line. The staff of financial analysts had been working hard over the last few weeks collecting data and had prepared a model creating a financial forecast about the proposed project's viability. Disaster had struck on the night of 4/27/23 wherein malware all but wiped out the work of the analysts. Shantel needed to prepare a financial analysis of the project to present the Board with recommendations. All the staff had already left for their annual vacation and Shantel was working alone. Shantel quickly reached the office and managed to salvage what was left of the excel spreadsheet prepared for the presentation. What follows is some basic information that Shantel knew and was able to retrieve about the project. PSUWC's existing plant has excess capacity, in a fully depreciated building, to install and run the new equipment to produce the new Designer Womens Tops line. Due to relatively rapid advances in technology, the project was expected to be discontinued in four years. The new Designer Womens Tops was expected to sell for $102 per unit and had projected sales of 4800 units in the first year, with a projected (Most-Likely scenario) 17.0% growth rate per year for subsequent years. A total investment of $888,000 for new equipment was required. The equipment had fixed maintenance contracts of $ 366,621 per year with a salvage value of $139,129 and variable costs were 6% of revenues. Shantel also needed to consider both the Best-Case and Worst-Case scenarios in the analysis with growth rates of 27.00% and 1.70% respectively. The new equipment would be depreciated to zero using straight line depreciation. The new project required an increase in working capital of $195,410 and $27,357 of this increase would be offset with accounts payable. PSUWC currently has 804000 shares of stock outstanding at a current price of $77.00. Even though the company has outstanding stock, it is not publicly traded and therefore there is no publicly available financial information. However, after analysis management believes that its equity beta is 0.85 . I he company aIso nas y UUUU bonas outstanaing, with a current price or $1, uro.uU. I he bonas pay interest semiannually at a coupon rate of 3.80%. The bonds have a par value of $1,000 and will mature in 14 years. The average corporate tax rate was 36%. Management believes the S\&P 500 is a reasonable proxy for the market portfolio. Therefore, the cost of equity is calculated using the company's equity beta and the market risk premium based on the S\&P 500 annual expected rate of return - Shantel would calculate the monthly expected market return using 5 years of past monthly price data available in the worksheet Marketdata. This would then be multiplied by 12 to estimate the annual expected rate. Shantel remembered that if the expected rate of return for the market was too low, too high, or negative, a forward looking rate of an historical average of about 9.5% would have to be used, as the calculated value for the current 5-year period may not be representative of the future. Shantel would consider a E(Rm) between 812% acceptable. Shantel would calculate the market risk premium: E(Rm)Rf from the previous calculations using the risk-free rate data available in the worksheet Marketdata. Shantel noted that the risk-free rate was on an annual basis. Shantel needed to calculate the rate at which the project would have to be discounted to calculate the Net Present Value (NPV) of the proposed project based on the decision of raising capital and the current capital market environment. This discount rate, the WACC, would obviously influence the NPV and could affect the decision of whether to accept or reject the project. Thankfully, all the information needed to calculate this was available. Shantel needed to clearly show all the calculations and sources for all parameter estimates used in the calculation of the WACC (and ultimately the NPV). Gathering all the available information, Shantel got a large cup of extra strong coffee and sat down to work on the development of the Capital Budgeting project model. The correct recommendation to the board was critical to the future growth of the firm! Shantel appreciated the detailed step by step instructions on the Worksheet 0 . Case Instructions - Luckily they were (Numerical Inputs Expected from you are highlighted in yellow and Formula/Function Inputs are highlighted in blue) Note Cells C21 and C22 include the initial (today's) cash flows. Column D through G are the operating cash flows. Spreadsheet for determining Cash Flows Cells G38-G40 contain the terminal cash flows. Timeline: Year 1 2 II. Net Investment Outlay = Initial CFs Price of Equipment Change in NWC III. Cash Flows from Operations 24 Revenue Generation \begin{tabular}{l|l} 25 & Unit Sales \\ 26 & Unit Sale Price \\ \hline \end{tabular} 27 Revenues \begin{tabular}{|rr|r|r|r|} \hline & 4800 & & & \\ \hline$ & 102.00 & & & \\ \hline$ & 489.600 .00 & & & \\ \hline \end{tabular} 28 Costs Variable Costs Fixed Costs Depreciation Eamings Before Taxes Taxes Net Income Depreciation Net operating CFs IV. Terminal Cash Flows Salvage Value Tax on Salvage Value Retum of NWC V. Final Cash Flow Cash Flows Present Value of CFs NPV of Project Summarize Answers for NPV under three cases in area below Note 1: Please use appropriate Cell referencing in Excel so that your numerical values update when you change any input(s). This will be helpful when you analyze the Best and Worst Case growth rate scenarios. Numerical Inputs expected from you are highlighted in yellow and Formula/Function Inputs are highlighted in blue. Step 1: Read the Full Case. On the "CapitalBudget" Worksheet: Step 2: Calculate the weights of Equity and Weights of Debt for the firm. Use the stock and bond data provided in the case. Step 3: Calculate the Cost of Equity for the firm. Use the CAPM and the Market data provided on on the Worksheet "MarketData". Step 4: Calculate the Cost of Debt for the firm. Use the information provided about the firms bonds to calculate the YTM. Step 5: Calculate the after-tax cost of debt. Use the given tax rate for the firm. Step 6: Use the results from steps 2-5 to calculate the WACC (Weighted Average Cost of Capital) for the firm. Step 7: Input the appropriate Initial Cash Outlays IMPORTANT: All cash inflows need to be POSITIVE and all cash outflows need to be NEGATIVE. Step 8: Input the appropriate Cash flows from Operations Step 9: Input the appropriate Terminal Cash flows. Step 10: Compute the Net Cash flows for Years 04. Step 11: Compute the PV of Net Cash flows for Years 0 - 4. (You can either use the EXCEL formula for PVO or use the mathematical formula for PV of a lump sum.) Step 12: Compute the NPV of the Net cash flows - This can be done as the sum of the PV's in Step 11 or using Excels NPV formula. Note 2: Excel's NPV formula needs to be adjusted by a factor of (1+I)-Refer to the module 14 notes on CANVAS for details. Step 13: Indicate the Accept/Reject decision for the most likely scenario. Note 3: Copy and paste the NPV values in cells C48 - C50 as you will need to input the NPV's for the 3 scenarios here - DO NOT REFERENCE values. Step 14: Compute the NPV for the Best Case scenario by changing to the Best Case growth rate in cell B11 and indicate the Accept/Reject Decision for this scenario. See Note 1 above - This is where it will be helpful. Step 15: Compute the NPV for the Worst Case scenario by changing to the Worst Case growth rate in cell B11 and indicate the Accept/Reject Decision for this scenario. On the "NPVProfile" Worksheet Step 16: Complete the table to generate a NPV profile for the Most-Likely Scenario. The graph will be automatically generated for you. Note 4: A sample calculation for generating a NPV profile is shown on the NPVProfile worksheet Step 17: Optional - Complete the Worksheet "Answer Sheet" as needed. (see instructions on the sheet) Hint: Explain/Clarify any assumptions or methods used. Note: Use this sheet to convey any comments to the instructor. Step 18: Double check your work Step 19: Save with Solutions for Most Likely Case and Upload your final Excel project by the due date. A Sample NPV Profile Most-Likely Case NPV Profile