Question
The Bob Co. Balance Sheet for the year ending December 31, 2016 is given below: BALANCE SHEET ($000) DECEMBER 31, 2016 ASSETS LIABILITIES Cash 4,000
The Bob Co. Balance Sheet for the year ending December 31, 2016 is given below:
BALANCE SHEET ($000)
DECEMBER 31, 2016
ASSETS LIABILITIES
Cash 4,000 Current Liabilities 40,000
Receivables 20,000 Long term Debta 125,000
Inventories 16,000 Common Stockb 200,000
Plant &
Equipment 325,000
Total Assets 365,000 Total liabilities 365,000
a The bond pays 8% coupon and has $1,000 par value. Since they are expected to be rolled over for a foreseeable future, for all practical purposes, they are perpetual bonds.
b $ 100 par value
The market value of common stocks is $50 per share. The market value of bonds is $800 each. The current liabilities are assumed to be free of cost and thus do not participate in determining the long-term cost of capital. The company's marginal corporate tax rate is 40%. The beta for this firm's equity is 1.25. The rate of return on market portfolio and the risk-free rate of return are 17% and 5% respectively.
Bob Co. is now considering the purchase of a machine that will cost $180,000. An additional $36,000 is required to put the equipment in position, in condition, and ready to use. This cost is added to the equipment cost for the purpose of computing CCA. The equipment will be the only asset in class 43 (30% CCA rate) and is expected to be sold at the end of year 3 for $80,000. The project initially requires an increase in net working capital (spare parts inventory) of $8,000, which will be recovered at the end of the project (end of the year 3). The equipment would have no effect on revenues, but it is expected to save ABC $100,000 per year (before-tax) in mainly labor related operating costs.
1. Determine the NPV for this project, and state whether the firm should accept or reject the project. ( use Excel chart)
2. Determine the Weighted Average Cost of Capital for the firm
Weighted Avg Cost of Capital ( WACC)
= (0.50 x 0.048) + (0.50 x 0.20)
.0240 + 0.10
= .124 or 12.4%
| Project changes to Income | year 0 | Year 1 | Year 2 | Year 3 |
| Operating costs ( labor related) | 100000 | 100000 | 100000 | |
| (less) Deprecition | -32400 | |||
| Change in EBIT | 67600 | |||
| Taxes 40% corp tax rate | 27040 | |||
| Change in Net Income | 40560 | |||
| Changes to Investments | ||||
| Change in Operationg Cash flow ( net income plus CCA) | 72960 | |||
| Net Working Capital | -8000 | 0 | 0 | 8000 |
| Equipment ( sold in yr 3) | -216,000 | 0 | 0 | 80000 |
| Total Cash Flow | -224,000 | 72960 |
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