Given this:

1. What discount rate (weighted average cost of capital) should Worldwide Paper Company (WPC) use to analyze the cash flows?

• Use (current long-term debt + long-term debt) as value of debt.
• Use market value of equity as value of equity.
• Use 10-year government bond yield as risk-free rate.
• Use 40% as tax rate.

INFORMATION GIVEN....

1. What yearly cash flows are relevant for this investment decision?
2. Find changes in net working capital relevant for this investment decision.

	2016	2017	2018	2019	2020	2021	2022
Sales revenue	0	4000	10000	10000	10000	10000	10000
NWC (10% of sales)	0	400	1000	1000	1000	1000	1000
DNWC = Cash flow	0	400	600	0	0	0	0

1. Find investment cash flows relevant for this investment decision.

	2016	2017	2018	2019	2020	2021	2022
Capital Outlay	16000	2000	0	0	0	0	0
DNWC	0	400	600	0	0	0	0	From Net Working Capital Cash Flows Table in Part (a)
Total Investment	(16000)	(2400)	(600)	0	0	0	0	Capital Outlay +DNWC
Equipment Recovery	0	0	0	0	0	0	(1080)	After-tax cash flow
Net Working Capital Full Recovery	0	0	0	0	0	0	(1000)

1. Find operating cash flows relevant for this investment decision. And, by combining investment cash flows and operating cash flows, find free cash flows relevant for this investment decision.

	2016	2017	2018	2019	2020	2021	2022
Sales Revenue	0	4000	10000	10000	10000	10000	10000
Cost of Goods Sold (75% Sales)	0	(3000)	(7500)	(7500)	(7500)	(7500)	(7500)
SG&A (5% Sales)	0	(200)	(500)	(500)	(500)	(500)	(500)
Operating Savings	0	2000	3500	3500	3500	3500	3500
Depreciation ($18,000/6)	0	(3000)	(3000)	(3000)	(3000)	(3000)	(3000)	Depreciation charges will not begin until 2017.
Total Costs & Expenses	0	(4200)	(7500)	(7500)	(7500)	(7500)	(7500)	Cost of Goods Sold + SG&A - Operating Savings + Depreciation
EBIT	0	(200)	2500	2500	2500	2500	2500	Sales Revenue - Total Costs & Expenses
Taxes (40%)	0	0	(1000)	(1000)	(1000)	(1000)	(1000)	EBIT*tax rate-since EBIT is negative, we assume no tax in the year.
NOPAT	0	(200)	1500	1500	1500	1500	1500	EBIT - Taxes
Depreciation	0	3000	3000	3000	3000	3000	3000
Investment	(16000)	(2400)	(600)	0	0	0	2080	(Total Investment - Equipment Recovery - Net Working Capital Full Recovery) from Investment Cash Flows Table
Free Cash Flow	(16000)	400	3900	4500	4500	4500	6580	NOPAT + Depreciation - Investment

You

16 hours ago

additional information 10- year 2.04% government bond Corporate Bond (10 year maturities) - A 3.85% Balance sheet Bank loan payable (LIBOR =+ 1%) 500 Long term debt 2500 Common equity 500 Retain earnings 2000 Per share data Share outstanding 500 Book value per share $5.00 Recent market value $24.00 Beta 1.10

You

16 hours ago

market risk premium - Historical average 6.0%

Answer from your tutor:

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DeanPuppy10846Answered10 hours ago

Discount rate = 7.37%

Explanation:

Total Debt = Bank loan payable + Long term debt

= 500 + 2500

= 3000

Total Equity = Market Value * Shares outstanding

= $24.00 * 500

=$12,000

Risk free rate = 10- year government bond

= 2.04%

Cost of debt = Corporate Bond (10 year maturities) - A

= 3.85%

Cost of equity = Risk-free rate + Beta * Market risk premium

= 2.04% + 1.10 * 6.0%

= 8.64%

Weighted average cost of capital = Cost of debt * (1-Tax rate) * (Total debt/(Total Debt+Total Equity)) + Cost of equity * (Total Equity/(Total Debt + Total Equity))

= 3.85% * (1-40%)*(3000/(3000+12000)) + 8.64%*(12000/(3000+12000))

= 7.37% Therefore discount rate to be used for Worldwide Paper company for analysis of cash flow is7.37%

1. What is the net present value (NPV) and internal rate of return (IRR) for the investment? How do you interpret these numbers?