Veronica Sarkozy, the CFO for the firm PSUWC Designer Jeans Company, LLC, woke up with a start at 4:00 am on 12/7/21, 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 12/6/21 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 $ 105 per unit and had projected sales of 5800 units in the first year, with a projected (Most-Likely scenario) 18.0 % growth rate per year for subsequent years. A total investment of $ 758,000 for new equipment was required. The equipment had fixed maintenance contracts of $ 303,074 per year with a salvage value of $ 145,621 and variable costs were 12 % of revenues. Veronica also needed to consider both the Best-Case and Worst-Case scenarios in the analysis with growth rates of 28.00% and 1.80 % respectively. The new equipment would be depreciated to zero using straight line depreciation. The new project required an increase in working capital of $221,710 and $ 35,474 of this increase would be offset with accounts payable. PSUWC currently has 828000 shares of stock outstanding at a current price of $76.00. 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 0.88. semi-annually at a coupon rate of 5.00%. The bonds have a par value of $1,000 and will mature in 8 years. The average corporate tax rate was 31 %. 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 retum - Veronica would calculate the monthly expected market retum 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 retum 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! Veronica appreciated the detailed step by step instructions on the Worksheet 0.Case Instructions - Luckily they I. Given the following data on proposed capital budgeting project. (Numerical Inputs Expected from you are highlighted in yellow and Formula/Function Inputs are highlighted in blue) 2 Economic life of project in years. 4 221.710.00 Parameters |# of Shares Outstanding 5 Price of New Equipment Change in NWC Fixed Costs B Variable Costs (% of Revenue) O Salvage value of New Equipment 0 Marginal Tax Rate 1 First Year Unit Sales 2 Sales Growth Rate 3 Unit Sale Price 4 First Year Revenue 5 6 7 Market Value of Equity Market Value of Debt |# of Bonds Outstanding Total Market Value Weight of Equity Weight of Debt $ Market Price of Bonds Market Price of Stock $ $ 905.00 76.00 E(RM) Rf 5800 18.00% B Cost of Equity (r.) $ 105.00 8 Spreadsheet for determining Cash Flows 9 Timeline: 0 II. Net Investment Outlay = Initial CFs 1 2 Price of Equipment Change in NWC Year 3 III. Cash Flows from Operations 4 5 6 Revenue Generation 7 8 Costs 9 0 1 2 3 4 5 6 7 IV. Terminal Cash Flows 8 9 0 1 V. Final Cash Flow 2 3 4 Unit Sales Unit Sale Price Revenues Variable Costs Fixed Costs Depreciation Earings Before Taxes Taxes Net Income Depreciation Net operating CFs Salvage Value Tax on Salvage Value Retum of NWC Cash Flows Present Value of CFs $ 5 NPV of Project 6 7 Summarize Answers for NPV under three cases in area below 8 9 Best Case 0 Most Likely 1 Worst Case 2 Sales Growth Rate 28.0% 18.00% 1.8% 0 (221,710.00) Cost of Debt (ra) After-Tax Cost of Debt WACC |Bond Info Provided for your convenience Years to Maturity PMT FV $1,000 Before tax YTM Before tax YTM * 2 Note Cells C21 and C22 include the initial (today's) cash flows. Column D through G are the operating cash flows. Cells G38-G40 contain the terminal cash flows. 1 $ 5800 105.00 609.000.00 NPV Accept? 2 3 8 S&P 500 Closing Data Company = 2 Date Adjusted Close Returns Risk Free Rate (R): 3. 12/1/2021 6052.76 4 11/1/2021 6041.29 5 10/1/2021 5977.27 5 9/1/2021 5843.03 7 8/1/2021 5857.88 B 7/1/2021 5789.51 9 6/1/2021 5706.22 0 5/1/2021 5679.48 1 4/1/2021 5539.30 2 3/1/2021 5454.59 3 2/1/2021 5368.74 4 1/1/2021 5318.45 5 12/1/2020 5157.03 6 11/1/2020 5125.67 7 10/1/2020 5176.11 8 9/1/2020 5166.93 9 8/1/2020 4990.94 20 7/1/2020 4937.96 1 6/1/2020 4838.07 2 5/1/2020 4753.22 23 4/1/2020 4603.27 24 3/1/2020 4574.57 5 2/1/2020 4572.36 26 1/1/2020 4610.74 27 12/1/2019 4437.30 28 11/1/2019 4315.10 9 10/1/2019 4271.99 30 9/1/2019 4328.18 $1 8/1/2019 4304.17 $2 7/1/2019 4253.06 3 6/1/2019 4199.46 4 5/1/2019 4271.58 35 4/1/2019 4208.06 $6 3/1/2019 4149.55 $7 2/1/2019 4108.57 18 1/1/2019 4076.71 19 12/1/2018 4064.26 40 11/1/2018 3975.67 41 10/1/2018 3946.90 42 9/1/2018 3967.60 13 8/1/2018 3919.14 44 7/1/2018 3972.86 45 6/1/2018 3974.53 46 5/1/2018 3927.97 47 4/1/2018 3805.66 48 3/1/2018 3758.12 19 2/1/2018 3777.46 60 1/1/2018 3774.74 $1 12/1/2017 3756.98 62 11/1/2017 3725.41 53 10/1/2017 3724.89 64 9/1/2017 3732.98 65 8/1/2017 3675.68 66 7/1/2017 3599.36 67 6/1/2017 3498.57 58 5/1/2017 3491.06 69 4/1/2017 3517.89 60 3/1/2017 3517.38 51 2/1/2017 3453.57 52 1/1/2017 3459.57 63 12/1/2016 3370.00 54 Step 2: Calculate the weights of Equity and Weights of Debt for the firm. Use the stock and bond data provided in the case. Step 3: Calculate the Cost of Equity for the firm. Use the CAPM and the Market data provided on on the Worksheet "MarketData". Step 4: Calculate the Cost of Debt for the firm. Use the information provided about the firms bonds to calculate the YTM.