Sap Paper Mill is considering $165 million upgrade of its machinery Once the plant is upgraded, the machinery will last for 30 years The upgrade is expected to generate the following net cash flows $28 million per year in the first decade after the investment $18 million per year in the second decade after the investment $10 million per year in the last decade of the investment At the end of the 30 th year, the firm anticipates that it will be able to sell the old equipment as parts for a total salvage value of $2 million Before committing to this investment, the company asked you, their Business Consultant, to evaluate this capital budgeting project given the various sources of funding available to them To assist you, the firm gathered the following data The firm's corporate tax rate is currently 21 percent This tax rate is not expected to change throughout the life of the project The company can issue 30 year bonds with a 5 coupon, paid semi annually, and par value of $1,000 The bonds will sell at their face value, but each bond will carry a flotation cost of 1 of the par value The current price of the firm's 8 percent, $100 par value, preferred stock is $113 If the firm issues new preferred stock, the firm will have to maintain the preferred stock dividend rate constant and pay $2 in flotation costs per each new preferred share issued The firms common stock is currently selling for $50 per share Its last dividend (D 0 ) was $4 20 per share Common stock dividends are expected to grow at a constant rate of 2 5 percent per year in the foreseeable future If the firm issues new common stock, the net proceeds per share are estimated to be 15 percent less than the current price of common share Saps beta is 1 70 The yield on a 30 year US Treasury Bond is 4 percent per year, and the S P 500 index has a rate of return of 8 percent per year The firms target capital structure is 30 percent long term debt, 10 percent preferred stock, and 60 percent common stock equity What is the firms weighted average cost of capital if the firm uses debt, preferred stock, and equity from the new common stock issue 15 points Should the firm finance the plants machinery upgrade If so, how should the firm finance it (using the weighted average cost of capital described in step 7 or 8) and why Provide evidence to support your recommendation (e g , calculate NPV and or IRR of the CAPEX project) 10 points

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Oct 03, 2024

Sap Paper Mill is considering $165 million upgrade of its machinery. Once the plant is upgraded, the machinery will last for 30 years. The upgrade

Sap Paper Mill is considering $165 million upgrade of its machinery. Once the plant is upgraded, the machinery will last for 30 years. The upgrade is expected to generate the following net cash flows:

$28 million per year in the first decade after the investment
$18 million per year in the second decade after the investment
$10 million per year in the last decade of the investment
At the end of the 30^th year, the firm anticipates that it will be able to sell the old equipment as parts for a total salvage value of $2 million.

Before committing to this investment, the company asked you, their Business Consultant, to evaluate this capital budgeting project given the various sources of funding available to them. To assist you, the firm gathered the following data:

The firm's corporate tax rate is currently 21 percent. This tax rate is not expected to change throughout the life of the project.
The company can issue 30-year bonds with a 5% coupon, paid semi-annually, and par value of $1,000. The bonds will sell at their face value, but each bond will carry a flotation cost of 1% of the par value.
The current price of the firm's 8 percent, $100 par value, preferred stock is $113. If the firm issues new preferred stock, the firm will have to maintain the preferred stock dividend rate constant and pay $2 in flotation costs per each new preferred share issued.
The firms common stock is currently selling for $50 per share. Its last dividend (D₀) was $4.20 per share. Common stock dividends are expected to grow at a constant rate of 2.5 percent per year in the foreseeable future.
If the firm issues new common stock, the net proceeds per share are estimated to be 15 percent less than the current price of common share.
Saps beta is 1.70. The yield on a 30-year US Treasury Bond is 4 percent per year, and the S&P 500 index has a rate of return of 8 percent per year.
The firms target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60 percent common stock equity.

What is the firms weighted average cost of capital if the firm uses debt, preferred stock, and equity from the new common stock issue? [15 points]

Should the firm finance the plants machinery upgrade? If so, how should the firm finance it (using the weighted average cost of capital described in step 7 or 8) and why? Provide evidence to support your recommendation (e.g., calculate NPV and/or IRR of the CAPEX project) [10 points]