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homework #23

Financial Planning & Control (PMBA 5373) Capital Budgeting Analysis Homework 23 (10 points) due 5:30 p.m., Monday, 12/6/21 Shown below is a comprehensive capital budgeting problem. It contains a complete description of the project being analyzed. The weighted average cost of capital (WACC) has already been calculated as have the relevant cash flows (initial, operating, terminal). Using the information in the comprehensive problem below, do the following: 1. calculate net present value (NPV): 2. calculate internal rate of return (IRR): 3. graph an NPV profile by using annual WACCs of 6%, 8%, 10%, 12%, 14%, 16%. 18%; perform a sensitivity analysis using values of "recover NWC" in the terminal cash flow of $0.00; S2000.00; 4,000.00; $6,000.00; $8,000.00; $10,000.00 4. The Bellich Company, a manufacturer of electronic components in the 40% marginal tax bracket, is considering the purchase of a new, fully automated machine to replace an older, manually. operated one. The machine being replaced, now five years old, originally had an expected life of 10 years. It was being depreciated using the simplified straight-line method from $25,000 down to zero, thus generating $2,500 in depreciation per year. The old machine could be sold today for $5,000. The old machine required one operator who earned $25,000 per year in salary and $5,000 per year in fringe benefits. The annual costs of maintenance and defects associated with the old machine were $6,000 and $3,500, respectively. The replacement machine under consideration has a purchase price of $95.000 and would be depreciated using the MACRS method using a 5-year recovery period. It is anticipated that the new machine could be sold after five years for $12,000. To get the automated machine in running order, there would be a $3,000 shipping fee and a $2,000 installation charge. In addition, because the new machine would work faster than the old one, revenues are expected to increase by $2500 per year and investment in raw materials and goods-in-process inventories would need to be increased by a total of $8,000 The annual costs of maintenance and defects on the new machine would be $1,500 and $4,000, respectively MACRS 3-year 33% 45 15 ownership year 1 2 3 4 5 6 7 8 9 10 11 Class of Investment 5-year 7-year 20% 14% 32 25 19 17 12 13 9 6 9 70-year 10% 18 14 12 9 7 7 7 7 6 3 9 4 The following is the current balance sheet for Bellich Company. All amounts are in millions of dollars. The current capital structure is to be maintained Cash $10 Accounts receivable 20 Inventories 20 Current assets 50 Gross fixed assets 100 Accum deprec 50 Net fixed assets 50 Accounts payable Accruals Short-term debt Current liabilities Long-term debt (bonds) Preferred stock Common stock Paid-in capital Retained carings Total liab and equity $10 10 5 25 30 5 2 8 30 100 100 Total Assets The following information has been gathered regarding Bellich Company's capital. The firm has outstanding an issue of 8% semiannual coupon, noncallable bonds with 12 years to maturity. New bonds with these characteristics could be sold for a price of $975.00. The bonds will have a par value of $1,000. Flotation costs on new bonds are expected to be 7.5%, 2. The current price of the firm's perpetual preferred stock (10% ammual dividend on $100 par value, dividends paid quarterly) is $125.50. New perpetual preferred stock could be sold to the public at this price, but Bellich would incur flotation costs of $5.50 per share 3. The firm's common stock is currently selling at $96 per share. The last dividend paid was Do = $4.00. Dividends are paid semiannually and investors expect the dividend to grow at a constant 7% annual rate into the foreseeable future. Any new common stock issued would involve flotation costs of 12%. Step 1. estimate the firm's weighted average cost of capital (WACC) Weights: Total capital --30+5+2+8+30 = 75 Wd-30/7504 - 40 -40% Wps = 5/75-067 = 6.7% Wce = (2+8+30)/75 - 533-53.3% Cost of debt: FV-1000; PMT -40; N=24; PV =- (975 - (975X0.075)) -901.88; CPT I/Y = 4.69 Yield-to-maturity = (4.69X2) = 9,38% Cost of preferred stock: Rps Div / price net of flotation cost = 2.50 / (125.50-5.50) = 2.50/120.00 = .0208 Adjust for quarterly dividends (.02084),0832 = 8.32% Cost of common equity: Ree - (D/price net of flotation cost )+g -[((4.00 + (035)(4.00))/((96 - (96)(.12))) + .035 - (4.14/84.48) +.035-046 Adjust for semiannual dividends (.084)2) = .168 - 16.8% Weighted Average Cost of Capital (WACC): WACC - War (I-1) + Wpal pe + Weece ( 40X.0936/(1-40) + (067).0832) + (-533).168) 0225 +.0056 +.0895.1176 = 11.76% Step 2 estimate the project's expected future cash flows Replacement Project Initial Cash Flow (t-0) purchase new -95000 shipping -3000 installation -2000 modification 0 training 0 invest in NWC -8000 sell old +5000 book value (old) - 25000 - (5X2500) - 12500 tax on sale +3000 LOSS - 12500 - 5000 = 7500 recover NWC 0 tax =(-40X7500) - 3000 net cash flow -100,000 Operating Cash Flows (1-5) 1 change in rev +2500 change in salary (exp) +25000 change in benefits (exp) +5000 change in maint (exp) +4500 change in defect (exp) -500 old deprec new deprec** change in deprec 2 -2500 425000 +5000 +4500 -500 +2500 -32000 -29500 +7000 -2800 +4200 +29500 33700 +2500 -20000 -17500 +19000 -7600 +11400 +17500 +28900 3 +2500 +25000 +5000 +4500 -500 +2500 -19000 -16500 +20000 -8000 +12000 +16500 +28500 +2500 +25000 +5000 +4500 -500 +2500 - 12000 -9500 +27000 -10800 +16200 +9500 25700 5 +2500 +25000 +5000 +4500 -500 2500 -11000 -8500 28000 -11200 +16800 +8500 +25300 change in EBT change in tax @ 40% change in EAT "undo" change in deprec net cash flow depreciable base - 95000 + 3000 + 2000 = 100,000 Annual depreciation amounts Year 1 - (20)(100000) - 20000 Year 2=(.32X100000) = 32000 Year 3 = (19)(100000) - 19000 Year 4 = 6.12)(100000) - 12000 Year 5 =(. 11X100000) - 11000 Year 6 =(.06)(100000) - 6000 Terminal Cash Flow (t-5) sell new +12000 tax on sale -2400 recover NWC +8000 net cash flow +17600 book value (new) - (06)(100000) - 6000 GAIN - 12000 - 6000 6000 tax = (40)(6000) = 2400 0 1 2 3 4 5years -100000 +28900 +33700 +28500 +25700 +25300 +17600 +42900 Financial Planning & Control (PMBA 5373) Capital Budgeting Analysis Homework 23 (10 points) due 5:30 p.m., Monday, 12/6/21 Shown below is a comprehensive capital budgeting problem. It contains a complete description of the project being analyzed. The weighted average cost of capital (WACC) has already been calculated as have the relevant cash flows (initial, operating, terminal). Using the information in the comprehensive problem below, do the following: 1. calculate net present value (NPV): 2. calculate internal rate of return (IRR): 3. graph an NPV profile by using annual WACCs of 6%, 8%, 10%, 12%, 14%, 16%. 18%; perform a sensitivity analysis using values of "recover NWC" in the terminal cash flow of $0.00; S2000.00; 4,000.00; $6,000.00; $8,000.00; $10,000.00 4. The Bellich Company, a manufacturer of electronic components in the 40% marginal tax bracket, is considering the purchase of a new, fully automated machine to replace an older, manually. operated one. The machine being replaced, now five years old, originally had an expected life of 10 years. It was being depreciated using the simplified straight-line method from $25,000 down to zero, thus generating $2,500 in depreciation per year. The old machine could be sold today for $5,000. The old machine required one operator who earned $25,000 per year in salary and $5,000 per year in fringe benefits. The annual costs of maintenance and defects associated with the old machine were $6,000 and $3,500, respectively. The replacement machine under consideration has a purchase price of $95.000 and would be depreciated using the MACRS method using a 5-year recovery period. It is anticipated that the new machine could be sold after five years for $12,000. To get the automated machine in running order, there would be a $3,000 shipping fee and a $2,000 installation charge. In addition, because the new machine would work faster than the old one, revenues are expected to increase by $2500 per year and investment in raw materials and goods-in-process inventories would need to be increased by a total of $8,000 The annual costs of maintenance and defects on the new machine would be $1,500 and $4,000, respectively MACRS 3-year 33% 45 15 ownership year 1 2 3 4 5 6 7 8 9 10 11 Class of Investment 5-year 7-year 20% 14% 32 25 19 17 12 13 9 6 9 70-year 10% 18 14 12 9 7 7 7 7 6 3 9 4 The following is the current balance sheet for Bellich Company. All amounts are in millions of dollars. The current capital structure is to be maintained Cash $10 Accounts receivable 20 Inventories 20 Current assets 50 Gross fixed assets 100 Accum deprec 50 Net fixed assets 50 Accounts payable Accruals Short-term debt Current liabilities Long-term debt (bonds) Preferred stock Common stock Paid-in capital Retained carings Total liab and equity $10 10 5 25 30 5 2 8 30 100 100 Total Assets The following information has been gathered regarding Bellich Company's capital. The firm has outstanding an issue of 8% semiannual coupon, noncallable bonds with 12 years to maturity. New bonds with these characteristics could be sold for a price of $975.00. The bonds will have a par value of $1,000. Flotation costs on new bonds are expected to be 7.5%, 2. The current price of the firm's perpetual preferred stock (10% ammual dividend on $100 par value, dividends paid quarterly) is $125.50. New perpetual preferred stock could be sold to the public at this price, but Bellich would incur flotation costs of $5.50 per share 3. The firm's common stock is currently selling at $96 per share. The last dividend paid was Do = $4.00. Dividends are paid semiannually and investors expect the dividend to grow at a constant 7% annual rate into the foreseeable future. Any new common stock issued would involve flotation costs of 12%. Step 1. estimate the firm's weighted average cost of capital (WACC) Weights: Total capital --30+5+2+8+30 = 75 Wd-30/7504 - 40 -40% Wps = 5/75-067 = 6.7% Wce = (2+8+30)/75 - 533-53.3% Cost of debt: FV-1000; PMT -40; N=24; PV =- (975 - (975X0.075)) -901.88; CPT I/Y = 4.69 Yield-to-maturity = (4.69X2) = 9,38% Cost of preferred stock: Rps Div / price net of flotation cost = 2.50 / (125.50-5.50) = 2.50/120.00 = .0208 Adjust for quarterly dividends (.02084),0832 = 8.32% Cost of common equity: Ree - (D/price net of flotation cost )+g -[((4.00 + (035)(4.00))/((96 - (96)(.12))) + .035 - (4.14/84.48) +.035-046 Adjust for semiannual dividends (.084)2) = .168 - 16.8% Weighted Average Cost of Capital (WACC): WACC - War (I-1) + Wpal pe + Weece ( 40X.0936/(1-40) + (067).0832) + (-533).168) 0225 +.0056 +.0895.1176 = 11.76% Step 2 estimate the project's expected future cash flows Replacement Project Initial Cash Flow (t-0) purchase new -95000 shipping -3000 installation -2000 modification 0 training 0 invest in NWC -8000 sell old +5000 book value (old) - 25000 - (5X2500) - 12500 tax on sale +3000 LOSS - 12500 - 5000 = 7500 recover NWC 0 tax =(-40X7500) - 3000 net cash flow -100,000 Operating Cash Flows (1-5) 1 change in rev +2500 change in salary (exp) +25000 change in benefits (exp) +5000 change in maint (exp) +4500 change in defect (exp) -500 old deprec new deprec** change in deprec 2 -2500 425000 +5000 +4500 -500 +2500 -32000 -29500 +7000 -2800 +4200 +29500 33700 +2500 -20000 -17500 +19000 -7600 +11400 +17500 +28900 3 +2500 +25000 +5000 +4500 -500 +2500 -19000 -16500 +20000 -8000 +12000 +16500 +28500 +2500 +25000 +5000 +4500 -500 +2500 - 12000 -9500 +27000 -10800 +16200 +9500 25700 5 +2500 +25000 +5000 +4500 -500 2500 -11000 -8500 28000 -11200 +16800 +8500 +25300 change in EBT change in tax @ 40% change in EAT "undo" change in deprec net cash flow depreciable base - 95000 + 3000 + 2000 = 100,000 Annual depreciation amounts Year 1 - (20)(100000) - 20000 Year 2=(.32X100000) = 32000 Year 3 = (19)(100000) - 19000 Year 4 = 6.12)(100000) - 12000 Year 5 =(. 11X100000) - 11000 Year 6 =(.06)(100000) - 6000 Terminal Cash Flow (t-5) sell new +12000 tax on sale -2400 recover NWC +8000 net cash flow +17600 book value (new) - (06)(100000) - 6000 GAIN - 12000 - 6000 6000 tax = (40)(6000) = 2400 0 1 2 3 4 5years -100000 +28900 +33700 +28500 +25700 +25300 +17600 +42900