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1 (15) Calliope Company is considering an investment of $60 million in plant and machinery. The property and machinery will be depreciated to a zero book value based on MACRS. It is in the 3-year property class. The firm has a 4-year planning horizon. The machinery will be sold at the end of 4 years for $5 million (there is no horizon value). The investment is expected to produce sales of $45 million in year 1 and $80 million in year 2 and to grow by 6% each year for the remaining two years. Cost of goods sold is expected to be 40% of sales and does not include the depreciation expense. Fixed operating costs are $4 million in year 1 and increase by 3% each year for the remaining 3 years. The tax rate is 40%. Net operating working capital is 2% of next year's sales. a b Calliope has a target debt ratio (debt/value) of .30. The cost of debt is 10% and the cost of equity is 25%. Use the weighted average cost of capital (WACC) to find the net present value. Should Calliope invest? Why or why not? Now you are told the project is riskier than the firm's average projects. How does this impact your decision? 2 (15) Bar plans to finance a new project with $2M in bonds, $1M in preferred stock and $5M in retained earnings. These proportions are the same as their target weights. The zero coupon bonds have a 5-year life and sold for $680.58. The preferred stock has a $2.70 annual dividend. The preferred stock has a price of $30 but issue costs are $3 per share. Bar knows the Treasury bill rate is 3% and the market risk premium is 9%. The common stock has a beta of 1.20. The tax rate is 30%. The project has a 5-year planning horizon. It costs $8,000,000 and generates $2,100,000 in after-tax cash flows every year for 4 years followed by an after-tax cash flow of $4,100,000 in year 5. Find the net present value of the project using the WACC. 3 4 (10) Your firm wants to lease a $500,000 piece of equipment. The equipment has a 5-year life and a salvage value of $100,000 at the end of year 5. Depreciation is straight-line over 5 years to a zero book value. There will be 5 pre-paid lease payments on the equipment. Purchasing the asset has a positive NPV for your firm. Assume the tax rate is equal to 30%. The before-tax cost of debt is 7%. What is the maximum before-tax payment your firm is willing to make? (10) Use the information below to estimate the price for Google. Data from Yahoo Finance GOOG YHOO FB Industry Market Cap: 477.59B 27.52B 268.58B 338.18M Employees: 59,976 12,500 11,996 437.00 Qtrly Rev Growth (yoy): 0.13 0.07 0.41 0.20 Revenue (ttm): 71.76B 4.95B 15.94B 143.22M Gross Margin (ttm): 0.63 0.64 0.84 0.54 EBITDA (ttm): 23.30B 477.08M 6.66B 6.64M Operating Margin (ttm): 0.26 0.01 0.30 0.01 Net Income (ttm): 15.44B 242.25M 2.81B N/A EPS (ttm): 23.72 0.25 1.00 0.02 P/E (ttm): 29.27 116.56 95.35 29.23 PEG (5 yr expected): 1.53 -1.56 1.43 1.02 P/S (ttm): 6.85 5.79 17.45 3.38 Note: ttm = trailing twelve months; yoy = year over year Market cap = market capitalization = market value of equity = price x shares outstanding EPS is earnings per share, PE is the ratio of price to earnings (P/E ratio), PEG is the P/E ratio divided by the five-year expected growth rate, and PS is the price to sales ratio (the market capitalization divided by total sales. a. What price would Google shares sell for if Google had the same P/E ratio as Yahoo? b. What price would Google shares sell for if Google had the same market cap/EBITDA as Facebook? Assume the number of shares outstanding is 345.5 million. c. Briefly compare your results to the current price of Google. 5 (10) You have the monthly returns for Rain Under Membranes (RUM) and for the S&P 500 (market). Use regression to estimate the characteristic line. Months RUM S&P 500 Aug 0.09% -3.10% Sept 10.52% 3.49% Oct 2.92% 4.43% Nov -6.10% 1.90% Dec 5.49% 0.62% Jan -.84% -2.88% Feb 1.65% 1.34% a b Find the alpha and beta for RUM. What does this tell you about RUM's stock? What part of RUM's return is explained by the market? Solution 1(a) Investment in Plant and Machinery = Initial Investment in Net Operating Working Capital = 2%*45,000,000 Depriciation Schedule Year 1 2 3 4 Machinery will be sold at the end of 4 years Less: Book Value Profit on sale of Plant at the End of the Project Weight of Debt (Wd) = Debt/Value = Cost of debt (Kd) = Weight of Equity (We) = 1-30% Cost of Equity (Ke) = WACC = Wd*Kd*(1-40%) + We*Ke WACC = (0.3*0.10)*(1-40%) + (0.7*0.25) = Year 0 1 2 3 4 Sum of PV Of C Net Present Value = Sum of PV Of Cash Flow = -60900000+16931433.36+24802406 Net Present Value = Sum of PV Of Cash Flow = Yes Calliope should invest since Net Present Value is greater than 0. Solution 1(b) Since the project is riskier than the firm's average project, therefore discount rate should be more than the i.e. Discount rate = WACC + (risk premium) IRR = =IRR{-60900000;20199200;35300000;29738480;34515535.2} = After adding risk premium to the WACC, the NPV of the project will decline, as long 60,000,000 900,000 chedule Depriciation Rate 33.33% Depriciation 19,998,000.00 44.45% 26,670,000.00 14.81% 8,886,000.00 7.41% 4,446,000.00 5,000,000 0 5,000,000 30% 10% 70% 25% e*Ke 19.300% Cash Flow =-(60000000+900000) -60,900,000 20,199,200 20,199,200 35,300,000 35,300,000 29,738,480 29,738,480 34,515,535 34,515,535 Sum of PV Of Cash Flow = PV Of Cash Flow = Cash Flow/(1+WACC)^n -60,900,000.00 16,931,433.36 24,802,406.33 17,514,487.59 17,039,342.69 15,387,669.96 h Flow = -60900000+16931433.36+24802406.32+17514487.59+17039342.68 15,387,669.96 Answer 1 (a) alue is greater than 0. refore discount rate should be more than the WACC in accordance with the risk associated. 31.034% , the NPV of the project will decline, as long as the project discount rate = IRR i.e 31.034% Calliope can invest in the Project. Year 1 2 3 Growth in Sales Sales Sales Less: Cost of goods sold (40% of Sales) 45,000,000 45,000,000 6% 80,000,000 =80000000*(1+0.06) 80,000,000 84,800,000 18,000,000 32,000,000 33,920,000 Less Depriciation = 19,998,000 26,670,000 8,886,000 Less: Fixed operating costs (increase by 3% per year) 4,000,000 4,120,000 4,243,600 0 0 0 3,002,000 1,200,800 1,801,200 19,998,000 17,210,000 6,884,000 10,326,000 26,670,000 37,750,400 15,100,160 22,650,240 8,886,000 1,600,000 20,199,200 1,696,000 35,300,000 1,797,760 29,738,480 Add: Sale Plant at the End of the Project Profit Before Tax Less: Tax @ 40% Profit after Tax Add: Depriciation Less: Net Operating Working Capital = 2% of next year's sales Cash Flow 4% Calliope can invest in the Project. Answer 1(b) 4 6% =84800000*(1+0.06) 89,888,000 35,955,200 4,446,000 4,370,908 5,000,000 50,115,892 20,046,357 30,069,535 4,446,000 34,515,535 Salvage Value and its Tax Effect has been included in our analysis. Bonds Preferred Stock 2,000,000 1,000,000 Retained Earnings 5,000,000 Total Capital = 8,000,000 Zero Coupon Bonds Life (Maturity) Price Par Value = 5 year life 680.58 1000 Cost of Debt (Bonds) (Kd) = (Par Value/Price)^(1/maturity) - 1 Cost of Debt (Bonds) (Kd) = (1000/680.58)^(1/5) - 1 Cost of Debt (Bonds) (Kd)= 8.00% Weight of Debt (Wd) = =2000000/8000000 = 25% Preferred Stock Annual dividend 2.7 Price = 30 Issue Cost = 3 Cost of Prefered Stock (Kp) = Dividend/(Price-issue cost) Cost of Prefered Stock (Kp) = 2.70/(30-3) Cost of Prefered Stock (Kp) = 10.00% Weight of Prefered Stock (Wp) =1000000/8000000 = 12.50% Risk Free Rate = Treasury bill rate = 3% Market Risk Premium = 9% Beta = 1.2 Tax Rate = 30% Cost of Equity (Ke) = RF + Beta*((Market Risk Premium) Cost of Equity (Ke) = 0.03+(1.2*0.09) Cost of Equity (Ke) = 13.80% Weight of Equity (We) = 5000000/8000000 = 62.50% Initial Cost of the Project = 8,000,000 Year (n) Cash Flows (CF) 0 1 2 3 4 5 -8,000,000 2,100,000 2,100,000 2,100,000 2,100,000 4,100,000 WACC = (Wd*Kd*(1-40%)) + (Wp*Kp) + (We*Ke) WACC = (0.25*0.080)*(1-40%) +(0.125*0.1) + 11.075% (0.625*0.138) = UpDated Net present value (NPV) = Sum of PV of Cash Flows = Net present value (NPV) = PV of Cash Flows = CF/(1+WACC)^n -8,000,000.00 1,890,614.19 1,702,105.72 1,532,392.97 1,379,601.85 2,424,945.32 =-8000000 + 1890614.19 + 1702105.72 + 1532392.96 + 1379601.85 + 2424945.31 929,660.05 Answer 2 Equipment Price Life Salvage Value at the end of 5 Years = Book Value at the of Year 5 Tax Rate Depriciation Per Year = 500000/5 Before tax Cost Of Debt = Cost Of Debt (Kd) = 7%*(1-30%) 500,000 5 Years 100000 0 30% 100,000 7.00% 4.90% Year Depriciation Depriciation Tax Sheild = Depriciation*Tax Rate 1 Add: After Tax Profit On sale of Equipment at the End of year 5 = (100000 -0)*(1-30%) 0 Benefits If Machine is Purchased= Present Value of Benefits If Machine is Purchased = 100,000 30,000 30,000 28598.6653956149 Present Value of Benefits If Machine is Purchased = 185,352.86 Actal Cost of Machine = (Equipment Price - Present Value of Benefits If Machin Actual Cost of Machine if Purchased = 500000 - 185352.86 = Maximum before-tax lease payment the firm is willing to make = =PMT(0.049,5,-314647.14,0) Year Lease Payments 1 Present Value of Lease Payments = Sum of Present Value of Lease Payments = 72,475 69,089.40 314,647.14 2 100,000 30,000 0 3 100,000 30,000 0 4 100,000 30,000 0 5 100,000 30,000 70000 30,000 30,000 30,000 100,000 27262.78874701 25989.31244 24775.321675 78726.79274 ent Value of Benefits If Machine is Purchased) 314,647 $72,474.78 2 Answer 5 72,475 3 72,475 4 72,475 5 72,475 65,862.15 62,785.66 59,852.87 57,057.07 Which is equal to Actual Cost of Machine if Purchased (as calculated above) Data Fron Yahoo Market Cap: Market Cap: Employees: Qtrly Rev Growth (yoy): Revenue (ttm): Gross Margin (ttm): EBITDA (ttm): EBITDA (ttm): Operating Margin (ttm): Net Income (ttm): EPS (ttm): P/E (ttm): PEG (5 yr expected): P/S (ttm): Current Price of Goolge = a) Google shares sell for if Google had the same P/E ratio as Yahoo = GOOG 477.59B 477,590,000,000 59,976 0.13 71.76B 0.63 23.30B 23300000000 0.26 15.44B 23.72 29.27 1.53 6.85 1,382.32 =116.56*23.72 b) Google shares sell for if Google had the same market =((268580000000/6660000000)*(233 cap/EBITDA as Facebook = 00000000))/345500000 c) Google shares are valued lower than the Facebook Stock. YHOO 27.52B 27520000000 12,500 0.07 4.95B 0.64 477.08M 477080000 0.01 242.25M 0.25 116.56 -1.56 5.79 2764.8032 2719.6142597 FB 268.58B 268,580,000,000 11,996 0.41 15.94B 0.84 6.66B 6660000000 0.3 2.81B 1 95.35 1.43 17.45 Industry 338.18M 338180000 437 0.2 143.22M 0.54 6.64M 6640000 0.01 N/A 0.02 29.23 1.02 3.38 Months RUM S&P 500 Risk Free Rate Aug Sept Oct Nov Dec Jan Feb 0.09% 10.52% 2.92% -6.10% 5.49% -0.84% 1.65% -3.10% 3.49% 4.43% 1.90% 0.62% -2.88% 1.34% 1.93% 1.93% 1.93% 1.93% 1.93% 1.93% 1.93% Average Return Earned by Market = 0.83% Beta = (Covariance of Market return& Stock Return)/(Variavce =COVARIANCE.S({0.0009;0.1052;0.0292;-0.061;0.0549;-0.0084 0.0288;0.0134})/VAR.S({-0.031;0.0349;0.0443; Beta = Beta = 0.67936 Answer OR Beta (Using Slope Function) Beta = 0.67936 OR Beta Using Regression analysis (Using Linest Function) CAPM Beta = 0.67936 Using Linest function CAPM Alpha = 1.39853271% OR Using Intercept CAPM Alpha = 1.39853271% Average Return earned by RUM = 1.96% Average Return earned by Market = 0.83% Answer B RUM Excess Return Market Excess Return -1.84% 8.59% 0.99% -8.03% 3.56% -2.77% -0.28% -5.03% 1.56% 2.50% -0.03% -1.31% -4.81% -0.59% Market return& Stock Return)/(Variavce of Market return) 9;0.1052;0.0292;-0.061;0.0549;-0.0084;0.0165},{-0.031;0.0349;0.0443;0.019;0.0062;0.0134})/VAR.S({-0.031;0.0349;0.0443;0.019;0.0062;-0.0288;0.0134})