Since the analysis of the capital budgeting project indicates that the project should not be implemented, Axylotl Industries, Inc. has a problem. They have already signed the contract to produce the material. Management is now searching for ways to make the project viable and has settled on exploring the potential opportunities of a different financial structure. The board has asked you to evaluate the cost of equity and the weighted average cost of capital for three alternative ways to finance the project.

First, finance the entire cost of the project, including working capital, at the existing debt to equity ratio and weighted average cost of capital. Second, finance the entire project investment with 50% debt and 50% equity and find the effect on the cost of capital. Third, finance the entire project investment with 100% equity. The latter two alternatives require a change in the cost of equity which results in a change in the weighted average cost of capital.

Use book weights and the following information in your calculation.

Market Risk Premium 0.09.

T-Bill Rate 0.03

T-Bond Rate 0.039

Tax Rate 0.35

Beta 1.25

Current Long-Term Debt Yield 0.058

Preliminary Discount Rate 0.14

H25 X fic D E F Book Weight 37000 96000 131200 264200 186000 21700 207700 471900 63000 0 17000 B C 4 5 Assets 6 Current Assets: Cash 7 Accounts Receivable 8 Inventory 9 Total Current Assets 10 Long-Term Assets: 11 Plant, Property and Equipment 12 Other Assets 13 Total Long-Term Assets 14 15 Total Assets 16 17 Liabilities and Equity 18 Current Liabilities: Accounts Payable 19 Commercial Paper 20 Accrued Expenses and Taxes 21 Long Term Debt Maturing within 1 Year 22 Capital Lease Obligations Due within 1 Year 23 Total Current Liabilities 24 Long Term Liabilities: 25 Long-Term Debt 26 Capital Lease Obligations 27 Deferred Income Taxes 28 Total Long-Term Liabilities 29 30 Total Liabilities 31 Shareholder Equity: 32 Common Stock 33 Capital in Excess of Par 34 Retained Earnings 35 Total Equity 36 37 Total Liabilities and Equity 38 39 80000 167500 167500 247500 18000 18000 188400 224400 471900 An Capital Budgeting Expansion Project Sales per Year, millions $ Sales Growth Rate per Year Building Cost, millions $ Building Life Building Depreciation Building Salvage Value, millions $ Equipment Cost, millions $ Equipment Installation Equipment Life Equipment Depreciation Equipment Salvage Value Cost of Goods Sold, % of Sales S, G and A Costs per Year, millions $ Working Capital, percent of Sales Tax Rate Cost of Capital Discount Rate 61000 0.035 19000 39 S/L 9000 55000 40000 10 MACRS 3000 0.62 8000 0.22 0.35 0.14 0.14 Cost of Capital Data Mkt. Risk Premium T-Bill Rate T-Bond Rate Tax Rate Beta LT Debt Yield ST Debt Yield Lease Cost 0.09 0.03 0.039 0.35 1.25 0.0580 Initial Discount Rate 0.14 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2020 $ (19,000) $ (95,000) $ (13,420) $ (470) $ (486) $ (503) $ (521) $ (539) $ (558) $ (577) $ (598) $ (619) $ $ 61,000 $ 63,135 $ 65,345 $ 67,632 $ 69,999 $ 72,449 $ 74,985 $ 77,609 $ 80,325 $ 83,137 $ (37,820) $ (39,144) $ (40,514) $ (41,932) $ (43,399) $ (44,918) $ (46,490) $ (48,118) $ (49,802) $ (51,545) $ 23,180 $ 23,991 $ 24,831 $ 25,700 $ 26,600 $ 27,531 $ 28,494 $ 29,491 $ 30,524 $ 31,592 $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (14,063) $ (23,753) $ (17,103) $ (12,353) $ (8,971) $ (8,961) $ (8,971) $ (4,724) $ (487) $ (487) $ 1,117 $ (7,761) $ (272) $ 5,347 $ 9,629 $ 10,569 $ 11,523 $ 16,767 $ 22,036 $ 23,105 $ (391) $ 2,716 $ 95 $ (1,872) $ (3,370) $ (3,699) $ (4,033) $ (5,869) $ (7,713) $ (8,087) $ 726 $ (5,045) $ (177) $ 3,476 $ 6,259 $ 6,870 $ 7,490 $ 10,899 $ 14,324 $ 15,018 $ 14,063 $ 23,753 $ 17,103 $ 12,353 $ 8,971 $ 8,961 $ 8,971 $ 4,724 $ 487 $ 487 $ 14,319 $ 18,222 $ 16,423 $ 15,308 $ 14,690 $ 15,273 $ 15,884 $ 15,025 $ 14,192 $ 15,505 33 34 Building 35 Equipment 36 Working Capital 37 38 Sales 39 Cost of Goods Solds 40 Gross Margin 41 S,G@A Expense 42 Depreciation - Total 43 Taxable income 44 Taxes @ 35% 45 Net Income 46 Depreciation 47 Net Operating Cash Flow 48 49 Working Capital Return 50 Salvage - Building + Equipment 51 Total Cash Flow 52 53 Cash Flows Discounted T 14% 54 55 56 NPV 57 $89,851.37 58 ($127,420.00) 59 ($37,568.63) 60 ($37,568.63) 61 IRR 62 0.0664 63 $ 18,290 $ 12,745 $ 15,308 $ 14,690 $ 15,273 $ 15,884 $ 15,025 $ 14,192 $ 46,540 $(127,420) $ 14,319 $ 18,222 $ 16,423 $ 58,457 $(127,420) $ 12,561 $ 14,021 $ 11,085 $ 9,063 $ 7,630 $ 6,958 $ 6,348 $ 5,267 $ 4,364 $ 12,554 H J F Includes Working Capital B D E Weighted Averale Cost of Capital - Book Value Same Capital Structure 2 3 Book Value of Each Component in the Capital Structure 1 5 Common Stock 5 Common Stock 18000 7 Paid in Excess 18000 B Ret. Earnings 188400 Book Values $ Book Value Wgt. in Capital Structure Common Stock Long Term Debt Short Term Debt Leases Total 167500 80000 247500 Note: Ignores acounts payable, accruals and deferred taxes. 0 Long-Term Debt 1 Book Value 167500 2 Current Portion 3 Total BV 4 5 Alternatively, include commercial paper with long-term debt. 6 (can use average outstanding or balance sheet amount) 7 8 Commercial Paper 9 0 Long-Term Debt incl. Commercial Paper: 1 2 3 4 5 6 7 8 9 0 1 2 3 Mkt. Risk Premium T-Bill Rate T-Bond Rate Tax Rate Beta LT Debt Yield ST Debt Yield Lease Cost D/E 0.09 0.03 0.039 0.35 1.25 0.0580 c D E F G I I K AT Cost of Equity A/T Cost of Equity AT Cost of LT Debt AT Cost of ST Debt AT Cost of Leases Component Cost BV Weight AT Cost A B 84 35 Cost of Components 36 37 Cost of Equity, Tbonds 38 Cost of Equity - Tbills 39 Cost of LT Debt, ritd 10 Cost of ST Debt, rstd 11 Cost of Leases, rl 42 13 WACC w/ T-bonds 74 45 46 47 18 19 50 51 52 WACC w/ T-Bills 53 54 55 56 57 58 59 50 61 52 53 ST Debt LT Debt Leases Common Stock Total Component Cost ST Debt LT Debt Leases Common Stock Total H25 X fic D E F Book Weight 37000 96000 131200 264200 186000 21700 207700 471900 63000 0 17000 B C 4 5 Assets 6 Current Assets: Cash 7 Accounts Receivable 8 Inventory 9 Total Current Assets 10 Long-Term Assets: 11 Plant, Property and Equipment 12 Other Assets 13 Total Long-Term Assets 14 15 Total Assets 16 17 Liabilities and Equity 18 Current Liabilities: Accounts Payable 19 Commercial Paper 20 Accrued Expenses and Taxes 21 Long Term Debt Maturing within 1 Year 22 Capital Lease Obligations Due within 1 Year 23 Total Current Liabilities 24 Long Term Liabilities: 25 Long-Term Debt 26 Capital Lease Obligations 27 Deferred Income Taxes 28 Total Long-Term Liabilities 29 30 Total Liabilities 31 Shareholder Equity: 32 Common Stock 33 Capital in Excess of Par 34 Retained Earnings 35 Total Equity 36 37 Total Liabilities and Equity 38 39 80000 167500 167500 247500 18000 18000 188400 224400 471900 An Capital Budgeting Expansion Project Sales per Year, millions $ Sales Growth Rate per Year Building Cost, millions $ Building Life Building Depreciation Building Salvage Value, millions $ Equipment Cost, millions $ Equipment Installation Equipment Life Equipment Depreciation Equipment Salvage Value Cost of Goods Sold, % of Sales S, G and A Costs per Year, millions $ Working Capital, percent of Sales Tax Rate Cost of Capital Discount Rate 61000 0.035 19000 39 S/L 9000 55000 40000 10 MACRS 3000 0.62 8000 0.22 0.35 0.14 0.14 Cost of Capital Data Mkt. Risk Premium T-Bill Rate T-Bond Rate Tax Rate Beta LT Debt Yield ST Debt Yield Lease Cost 0.09 0.03 0.039 0.35 1.25 0.0580 Initial Discount Rate 0.14 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2020 $ (19,000) $ (95,000) $ (13,420) $ (470) $ (486) $ (503) $ (521) $ (539) $ (558) $ (577) $ (598) $ (619) $ $ 61,000 $ 63,135 $ 65,345 $ 67,632 $ 69,999 $ 72,449 $ 74,985 $ 77,609 $ 80,325 $ 83,137 $ (37,820) $ (39,144) $ (40,514) $ (41,932) $ (43,399) $ (44,918) $ (46,490) $ (48,118) $ (49,802) $ (51,545) $ 23,180 $ 23,991 $ 24,831 $ 25,700 $ 26,600 $ 27,531 $ 28,494 $ 29,491 $ 30,524 $ 31,592 $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (8,000) $ (14,063) $ (23,753) $ (17,103) $ (12,353) $ (8,971) $ (8,961) $ (8,971) $ (4,724) $ (487) $ (487) $ 1,117 $ (7,761) $ (272) $ 5,347 $ 9,629 $ 10,569 $ 11,523 $ 16,767 $ 22,036 $ 23,105 $ (391) $ 2,716 $ 95 $ (1,872) $ (3,370) $ (3,699) $ (4,033) $ (5,869) $ (7,713) $ (8,087) $ 726 $ (5,045) $ (177) $ 3,476 $ 6,259 $ 6,870 $ 7,490 $ 10,899 $ 14,324 $ 15,018 $ 14,063 $ 23,753 $ 17,103 $ 12,353 $ 8,971 $ 8,961 $ 8,971 $ 4,724 $ 487 $ 487 $ 14,319 $ 18,222 $ 16,423 $ 15,308 $ 14,690 $ 15,273 $ 15,884 $ 15,025 $ 14,192 $ 15,505 33 34 Building 35 Equipment 36 Working Capital 37 38 Sales 39 Cost of Goods Solds 40 Gross Margin 41 S,G@A Expense 42 Depreciation - Total 43 Taxable income 44 Taxes @ 35% 45 Net Income 46 Depreciation 47 Net Operating Cash Flow 48 49 Working Capital Return 50 Salvage - Building + Equipment 51 Total Cash Flow 52 53 Cash Flows Discounted T 14% 54 55 56 NPV 57 $89,851.37 58 ($127,420.00) 59 ($37,568.63) 60 ($37,568.63) 61 IRR 62 0.0664 63 $ 18,290 $ 12,745 $ 15,308 $ 14,690 $ 15,273 $ 15,884 $ 15,025 $ 14,192 $ 46,540 $(127,420) $ 14,319 $ 18,222 $ 16,423 $ 58,457 $(127,420) $ 12,561 $ 14,021 $ 11,085 $ 9,063 $ 7,630 $ 6,958 $ 6,348 $ 5,267 $ 4,364 $ 12,554 H J F Includes Working Capital B D E Weighted Averale Cost of Capital - Book Value Same Capital Structure 2 3 Book Value of Each Component in the Capital Structure 1 5 Common Stock 5 Common Stock 18000 7 Paid in Excess 18000 B Ret. Earnings 188400 Book Values $ Book Value Wgt. in Capital Structure Common Stock Long Term Debt Short Term Debt Leases Total 167500 80000 247500 Note: Ignores acounts payable, accruals and deferred taxes. 0 Long-Term Debt 1 Book Value 167500 2 Current Portion 3 Total BV 4 5 Alternatively, include commercial paper with long-term debt. 6 (can use average outstanding or balance sheet amount) 7 8 Commercial Paper 9 0 Long-Term Debt incl. Commercial Paper: 1 2 3 4 5 6 7 8 9 0 1 2 3 Mkt. Risk Premium T-Bill Rate T-Bond Rate Tax Rate Beta LT Debt Yield ST Debt Yield Lease Cost D/E 0.09 0.03 0.039 0.35 1.25 0.0580 c D E F G I I K AT Cost of Equity A/T Cost of Equity AT Cost of LT Debt AT Cost of ST Debt AT Cost of Leases Component Cost BV Weight AT Cost A B 84 35 Cost of Components 36 37 Cost of Equity, Tbonds 38 Cost of Equity - Tbills 39 Cost of LT Debt, ritd 10 Cost of ST Debt, rstd 11 Cost of Leases, rl 42 13 WACC w/ T-bonds 74 45 46 47 18 19 50 51 52 WACC w/ T-Bills 53 54 55 56 57 58 59 50 61 52 53 ST Debt LT Debt Leases Common Stock Total Component Cost ST Debt LT Debt Leases Common Stock Total