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Text You are the CFO of Zetrax, a manufacturing company. You are considering launching a new product on the market. The project has a risk and financing structure that are in line with those of Zetrax. The tax rate is 30%. Operating information The new product has a gross margin of 20% and will sell EUR 8,000,000 next year. Sales of the new product will increase by 2% per year for the following 10 years, after which the product will be retired from the market. You expect that in the first year, 10% of the sales of the new product will cannibalize an existing product that has the same selling price and a gross margin of 10% (the old product will be retired from the market in one year anyway). Both the old and the new product require net working capital equal to 25% of sales in the current year. Launching the new product will require expanding the current production capacity. The production plant operates on a plot of land that has a market value of EUR 20,000,000 and a book value of EUR 15,000,000 (land is not depreciated). The plot has a surface of 40,000m', and 30,000m are occupied by the current plant. If the new product is launched the expansion of the plant will require the use of the remaining 10,000m of land, which could be sold at fair market value otherwise. The expansion of the production capacity will require EUR 300,000 to demolish an existing building that has a book value of EUR O. Construction costs will be EUR 5,000,000 (depreciated straight line over 8 years). Designing the production process has already cost EUR 200,000 and will require an additional EUR 300,000 if the product is launched. Financing information Zetrax could use a EUR 1,000,000, 10-year mortgage to finance part of the expansion investment. The interest rate on the mortgage would be 6% per annum compounded monthly. The firm would pay a constant monthly amount (including interest and repayment) for the next 10 years. In order to calculate the NPV of the investment, you need to determine an appropriate WACC. Zetrax is not listed and you gather the following information in order to value the equity of Zetrax. The risk free rate is 2.5% Inflation is 1.5% The expected market risk premium is 5.0% The cost of equity for Zetrax is 8.0% Zetrax has just paid a dividend of EUR 5 per share, which is expected to increase by 2% per year Zetrax has 1,700,000 shares outstanding In the past 12 months Zetrax had an ROE of 20% The book value per share is EUR 28 Competitors in the industry have an average P/E ratio of 15 Zetrax has issued last year a bond with an annual coupon of 5%, and a residual maturity of 9 years. Based on the credit rating of the bond, you estimate the credit spread of the company today at 2.0%. Based on these analyses, you determine that the D/E ratio of Zetrax is 0.75 and you calculate the WACC. Questions Question 1 What is the initial investment for the project? Question 2 What is the net operating income for Year 1? Question 3 What is the adjustment to net operating income in Year 3 due to net working capital investment? Question 4 Calculate the monthly payment on the mortgage. Will this payment enter the calculation of the incremental cash flow of the project? Question 5 Use the CAPM formula to calculate the beta of the company Question 6 Calculate the price of the stock using the DDM model Question 7 Calculate the value of the firm's equity using the P/E multiple Question 8 Calculate the value of the bond per 100 of par Question 9 Calculate the WACC of the project Text You are the CFO of Zetrax, a manufacturing company. You are considering launching a new product on the market. The project has a risk and financing structure that are in line with those of Zetrax. The tax rate is 30%. Operating information The new product has a gross margin of 20% and will sell EUR 8,000,000 next year. Sales of the new product will increase by 2% per year for the following 10 years, after which the product will be retired from the market. You expect that in the first year, 10% of the sales of the new product will cannibalize an existing product that has the same selling price and a gross margin of 10% (the old product will be retired from the market in one year anyway). Both the old and the new product require net working capital equal to 25% of sales in the current year. Launching the new product will require expanding the current production capacity. The production plant operates on a plot of land that has a market value of EUR 20,000,000 and a book value of EUR 15,000,000 (land is not depreciated). The plot has a surface of 40,000m', and 30,000m are occupied by the current plant. If the new product is launched the expansion of the plant will require the use of the remaining 10,000m of land, which could be sold at fair market value otherwise. The expansion of the production capacity will require EUR 300,000 to demolish an existing building that has a book value of EUR O. Construction costs will be EUR 5,000,000 (depreciated straight line over 8 years). Designing the production process has already cost EUR 200,000 and will require an additional EUR 300,000 if the product is launched. Financing information Zetrax could use a EUR 1,000,000, 10-year mortgage to finance part of the expansion investment. The interest rate on the mortgage would be 6% per annum compounded monthly. The firm would pay a constant monthly amount (including interest and repayment) for the next 10 years. In order to calculate the NPV of the investment, you need to determine an appropriate WACC. Zetrax is not listed and you gather the following information in order to value the equity of Zetrax. The risk free rate is 2.5% Inflation is 1.5% The expected market risk premium is 5.0% The cost of equity for Zetrax is 8.0% Zetrax has just paid a dividend of EUR 5 per share, which is expected to increase by 2% per year Zetrax has 1,700,000 shares outstanding In the past 12 months Zetrax had an ROE of 20% The book value per share is EUR 28 Competitors in the industry have an average P/E ratio of 15 Zetrax has issued last year a bond with an annual coupon of 5%, and a residual maturity of 9 years. Based on the credit rating of the bond, you estimate the credit spread of the company today at 2.0%. Based on these analyses, you determine that the D/E ratio of Zetrax is 0.75 and you calculate the WACC. Questions Question 1 What is the initial investment for the project? Question 2 What is the net operating income for Year 1? Question 3 What is the adjustment to net operating income in Year 3 due to net working capital investment? Question 4 Calculate the monthly payment on the mortgage. Will this payment enter the calculation of the incremental cash flow of the project? Question 5 Use the CAPM formula to calculate the beta of the company Question 6 Calculate the price of the stock using the DDM model Question 7 Calculate the value of the firm's equity using the P/E multiple Question 8 Calculate the value of the bond per 100 of par Question 9 Calculate the WACC of the project
