Question
THE CLARNEDON COMPANY PART III You have been appointed as the new CEO of The Clarendon Company, just as the pandemic seems to diminish and
THE CLARNEDON COMPANY PART III
You have been appointed as the new CEO of The Clarendon Company, just as the pandemic seems to diminish and come to an end.
The Board has entrusted you with an important task: evaluate a project of acquiring another company. The main option is a direct competitor who was smitten severely by the pandemic.
This company will require that you buy all their assets (which have already been depreciated) for an amount of 740,000,000 USD. Renovations must be put in place, so you consider the necessity of new equipment cost of 60,000,000 USD, including freight and installation charges. You should consider a life expectancy of this new equipment of 5 years, with a selling price of 25,000,000 USD at the end of year 5. This means that a salvage value must be calculated and included. Depreciation for the new equipment should consider the reducing-balance method at a rate of 20% for tax purposes. (Hint: Primer Examen Parcial).
The good thing about buying an existing company, is that it already has income that you can benefit from since year 1. The income expected are as follows:
Year 1: 400,000,000 USD Year 2: 800,000,000 USD Year 3: 1,000,000,000 USD Year 4 is expected to increase 25% from Year 3. Year 5 is expected to generate 12% more revenue than Year 4.
The actual operation of the company considers 20,000,000 USD of fixed costs. Salaries will be 20% of income, and Marketing and promotion costs will be 30% of income. Additions to current assets will require $16,000,000 at the beginning and are assumed to be fully recoverable at the end of the fifth year of the project. The tax rate is 35%.
In the last year, The Clarendon Company has significantly changed its capital structure. It needs to be considered that:
There is no preferred stock. The Clarendon Company has restructured its bond issues outstanding. You only must consider the following: A bond issue that has a face value of $100 million and a 12 percent coupon and sells for 94 percent of par. It matures in 8 years and it makes annual payments. (Hint: Remember to calculate the market value of debt) The risk-free rate is 6 percent, and the market risk premium is 11 percent. The beta for this project can be consideres as 2. The market value of the Equity is 166,000,000 USD. Should you buy this company?
Answer the following questions:
a) What is the book value of the equipment at the end of the 5th year? b) What is the after-tax salvage value of the equipment? c) What is the Cost of Equity (RE)? d) What is the Cost of Debt (RD)? e) What is the Weighted Average Cost of Capital? f) What is the Net Present Value of the project? g) What is the Internal Rate of Return of the project?
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