In January 2020, Mr. Yavuz, chairman and chief executive officer of TCBF faced an important decision about expanding his food company into a new line of frozen food products. The proposed $5 million project, Mr. Yavuz thought, would lead to a paradigm shift for consumers concerned about food safety during the COVID-19 pandemic.

It was difficult to obtain accurate data on sales and profitability of the variouscompetitors because most of them tended to be local, privately-owned subcontractors. However, there were six publicly traded companies: Agro Blast, Flash Buds, Green Thumbs, Healthy Grains, Macro Tastes, and Yummy Veggies. Only Agro Blast and Flash Buds concentrated in the frozen food industry, while the other four had additional business segments such as canned and packaged foods. Summary data for these six companies are shown in Exhibits 2.

Staff had determined that it would cost $5 million to install the machinery necessary to make frozen food products. If the engineering work started in the first quarter of 2020, the project could be finished by the beginning of 2021. Staff had also projected that it would be necessary to invest heavily in advertising and marketing in the early years. The brand image of a new product was an essential contributor to success.

Pro forma data for the project are shown in Exhibit 3, which assumes that the annual inflation rate will be 4%. Current operating liabilities of the project were expected to be 9% of total sales. The tax rate on income from the project was expected to be 35% (the combined U.S. federal and Texas state tax rate). Any losses from the project in the early years would be used to offset the company's profits. Some data on capital market conditions are provided below. Please answer the following questions.

QUESTIONS:

1. Based on the Capital Asset Pricing Model, what is the appropriate weighted average cost of capital for TCBF's investment in the new project to make frozen food products?

2.Prepare a sensitivity analysis for WACC for the following cases:

i. Debt ratio of 0%

ii. Debt ratio of 10%

iii. Debt ratio of 50%

From now on you can assume that the weighted average cost of capital is 14%.

3.What are the forecasted free cash flows for the project through 2026?

4.What is the present value of these cash flows?

5.On the assumption that the project lasts forever with the appropriate maintenance, what is the terminal value of the project if there is no real growth beyond 2026? What is the total value of the project?

6.Conduct an alternate valuation of the project by using the market-to-book ratio of comparable firms. (Hint: You first need to calculate the market-to-book ratios for the comparable firms using the data given.)

Selected Capital Markets Data in December 2019

Interest Rate - Long Term AAA5.2%

Interest Rate - Long Term AA5.5%

Interest Rate - Long Term A5.8%

Interest Rate - Long Term BBB6.1%

Short Term T-Bills4.8%

Long Term Government Bonds5.0%

MRP7.5%