Scenario: Veronica Sarkozy, the CFO for the firm PSUWC Designer Jeans Company, LLC, woke up with a start at 4:00 am on 2021/12/12, due to the phone ringing. It was the firms senior financial analyst, vacationing in Europe, calling with bad news. Veronica was supposed to present the project evaluation, at the end of the week, for the Board's proposal that they invest in new equipment which would enable them to add a new product line. Currently PSUWC has four successful products and they are considering selling a new Designer Jeans line. The staff of financial analysts had been working hard over the last few weeks collecting data and had prepared a model creating a financial forecast about the proposed project's viability. Disaster had struck on the night of 2021/12/11 wherein malware all but wiped out the work of the analysts. Veronica needed to prepare a financial analysis of the project to present the Board with recommendations. All the staff had already left for their annual vacation and Veronica was working alone. Veronica quickly reached the office and managed to salvage what was left of the excel spreadsheet prepared for the presentation. What follows is some basic information that Veronica knew and was able to retrieve about the project. PSUWC's existing plant has excess capacity, in a fully depreciated building, to install and run the new equipment to produce the new Designer Jeans line. Due to relatively rapid advances in technology, the project was expected to be discontinued in four years. The new Designer Jeans was expected to sell for $ 106 per unit and had projected sales of 4500 units in the first year, with a projected (Most-Likely scenario) 21.0 % growth rate per year for subsequent years. A total investment of $ 875,000 for new equipment was required. The equipment had fixed maintenance contracts of $ 246,875 per year with a salvage value of $ 124,461 and variable costs were 7 % of revenues. Veronica also needed to consider both the Best-Case and Worst-Case scenarios in the analysis with growth rates of 31.00 % and 2.10 % respectively.

The new equipment would be depreciated to zero using straight line depreciation. The new project required an increase in working capital of $ 177,610 and $ 26,642 of this increase would be offset with accounts payable. PSUWC currently has 1210000 shares of stock outstanding at a current price of $ 79.00. Even though the company has outstanding stock, it is not publicly traded and therefore there is no publicly available financial information. However, after analysis management believes that its equity beta is 0.86.

The company also has 122000 bonds outstanding, with a current price of $ 1,063.00. The bonds pay interest semi-annually at a coupon rate of 5.90 %. The bonds have a par value of $1,000 and will mature in 14 years. The average corporate tax rate was 36 %. Management believes the S&P 500 is a reasonable proxy for the market portfolio. Therefore, the cost of equity is calculated using the company's equity beta and the market risk premium based on the S&P 500 annual expected rate of return - Veronica would calculate the monthly expected market return using 5 years of past monthly price data available in the worksheet Marketdata. This would then be multiplied by 12 to estimate the annual expected rate. Veronica remembered that if the expected rate of return for the market was too low, too high, or negative, a forward looking rate of an historical average of about 9.5% would have to be used, as the calculated value for the current 5-year period may not be representative of the future. Veronica would consider a E(Rm) between 8-12% acceptable. Veronica would calculate the market risk premium: E(Rm) - Rf from the previous calculations using the risk-free rate data available in the worksheet Marketdata. Veronica noted that the risk-free rate was on an annual basis. Veronica needed to calculate the rate at which the project would have to be discounted to calculate the Net Present Value (NPV) of the proposed project based on the decision of raising capital and the current capital market environment. This discount rate, the WACC, would obviously influence the NPV and could affect the decision of whether to accept or reject the project. Thankfully, all the information needed to calculate this was available. Veronica needed to clearly show all the calculations and sources for all parameter estimates used in the calculation of the WACC (and ultimately the NPV). Gathering all the available information, Veronica got a large cup of extra strong coffee and sat down to work on the development of the Capital Budgeting project model. The correct recommendation to the board was critical to the future growth of the firm!

0 $ (177,610.00) $ $ 4500 106.00 477,000.00 Timeline: Year II. Net Investment Outlay = Initial CFs Price of Equipment Change in NWC III. Cash Flows from Operations Revenue Generation Unit Sales Unit Sale Price Revenues Costs Variable Costs Fixed Costs Depreciation Earnings Before Taxes Taxes Net Income Depreciation Net operating CFS IV. Terminal Cash Flows Salvage Value Tax on Salvage Value Return of NWC V. Flow Cash Flows Present Value of CFs NPV of Project Summarize Answers for NPV under three cases in area below Sales Growth Rate NPV Accept? Best Case 31.0% Most Likely 21.00% Worst Case 2.1%