It is estimated that Cape Chemical must increase its annual blending capacity by $800,000$ gallons to meet expected demand for the next three years Annual capacity must increase by $1,400,000$ gallons to meet projected demand beyond the next three years. The first is the acquisition and installation of used equipment that will provide the capacity to blend an additional $800,000$ gallons annually. The used equipment will cost $$105,000$ to acquire and $$15,000$ to install. The equipment is projected to have an estimated life of three years. The second option is the acquisition and installation of new equipment with the capacity to blend $1,600,000$ gallons annually. The new equipment would have a substantially higher cost of $$360,000$ to acquire and $$60,000$ to install, but have a higher capacity and an economic life of seven years. The new equipment is also more efficient thus the cost of blending is less than the blending cost of the used equipment. The used equipment could be obtained without a new bank loan. The acquisition of the new equipment would require new bank borrowing. The marketing and sales staff estimated incremental sales of blended package material will be $600,000$ gallons the first year and increase by $15\%$ each year thereafter. During the last year, the average selling price for blended material has been near $$4\mathrm{.}05$ per gallon and material cost $($not including a cost for blending the material$)$ has been approximately $$3\mathrm{.}53.$ There should be no significant change in either future selling prices or product costs; however it is estimated variable selling and administrative expenses associated with the increased blended material sales to be $$\mathrm{.}20$ per gallon. A plan is needed to develop a formal capital budgeting process using the Cash Payback Period, Discounted Cash Payback Period, Net Present Value $($NPV$),$ Internal Rate of Return $($IRR$)$ and Modified Internal Rate of Return $($MIRR$)$ evaluation methods. Weighted Average Cost of Capital $($WACC$)$ Using input from an investment banking firm, Clarkson estimates the company's cost of equity to be $18\%.$ Their bank has indicated a long$-$term bank loan can be arranged to finance the new equipment at an annual interest rate of $12\%($before tax cost of debt$).$ The bank would require the loan to be secured with the new equipment. The loan agreement would also include a number of restrictive covenants, including a limitation of dividends while the loans are outstanding. A $30\%$ debt, $70\%$ equity capital mix would be appropriate for Cape Chemical. Last year, the company's federalplus$-$state income tax rate was $30\%.$ It is not expected for income tax rate to change in the foreseeable future. Used Equipment The used equipment will cost $$105,000$ with another $$15,000$ required to install the equipment. The equipment is projected to have an economic life of three years with a salvage value of $$9,000.$ The equipment will provide the capacity to blend an additional $800,000$ gallons annually. The variable cost to blending cost is estimated to be $$\mathrm{.}20$ per gallon. The equipment will be depreciated under the Modified Accelerate Cost Recovery System $($MACRS$)3-$year class. Under the current tax law, the depreciation allowances are $0\mathrm{.}33,0\mathrm{.}45,0\mathrm{.}15,$ and $0\mathrm{.}07$ in years $1$ through $4,$ respectively. The increased sales volume will require an additional investment in working capital of $2\%$ of sales $($to be on hand at the beginning of the year$).$ The acquisition of new equipment with the capacity to blend $1,600,000$ gallons annually is the second alternative. The new equipment would cost $$360,000$ to acquire with an installation cost of $$60,000$ and have an economic life of seven years and a salvage value of $$60,000.$ The new equipment can be operated more efficiently than the used equipment. The cost to blend a gallon of material is estimated to be $$\mathrm{.}17.$ The equipment will be depreciated under the MACRS $7-$year class. Under the current tax law, the depreciation allowances are $0\mathrm{.}14,0\mathrm{.}25,0\mathrm{.}17,0\mathrm{.}13,0\mathrm{.}09,0\mathrm{.}09,0\mathrm{.}09$ and $0\mathrm{.}04$ in years $1$ through $8,$ respectively. The increased sales volume will require an additional investment in working capital of $2\%$ of sales $($to be on hand at the beginning of the year$).$

Conduct a cash flow analysis for each alternative and provide recommendations to Cape Chemical.

$1)$ Calculate Cape Chemical$$s weighted average cost of capital $($WACC$).$ Round to the nearest whole number. Discuss the theory used by Clarkson to determine Cape Chemical$$s optimum target capital structure $(30\%$ debt and $70\%$ equity$).$

$2)$ Since the used equipment will be financed with internal capital and the new equipment with a bank loan, should the same discount rate be used to evaluate each alternative? Explain.

$3)$ Explain why an accurate WACC is important to a firm's long$-$term success.

Provide at least one paragraph of supporting explanation in response to each question.

Provide an Excel spreadsheet with solutions to each question on a separate worksheet; formulas in the spreadsheet must be linked;