Wacc, capm, cost of equity, cost of debt
Industrial Air Filtration System (IAFS) Projections The Ventilation Division will manufacture the IAFS using idle facilities. This plant can produce up to 200 units per year over the product's 10-year life. An outside appraiser indicated that the plant is worth CAD 2,750,000, which breaks down as CAD 1,250,000 for the land and CAD 1,500,000 for the building. New production equipment costing CAD 5,300,000 is also required. It is believed that the land will have a residual value of CAD 1,500,000 at the end of the project's life, while the building and equipment will be worth CAD 350,000 and CAD 250,000. The building is subject to a CCA rate of 4.0% and the equipment is subject to a CCA rate of 20.0%. Incremental net working capital of CAD 550,000 is also needed which will be liquidated at the end of the product's life. APSI sales are estimated to be 75 units in the first year and will grow by 25.0% a year until plant capacity is reached. The unit price is CAD 125,000 and unit costs are CAD 103,500 per unit, which includes direct materials, direct labour, and manufacturing overhead. The Ventilation Division must also pay a CAD 10,000 licensing fee per unit for the vacuum cleaner technology. Incremental selling and administration costs will be CAD 360,000 per year. Discount Rate In the past, MDFA used a corporate cost of capital to evaluate the feasibility of its new product proposals. Denison felt this rate was inaccurate as it reflected the weighted-average cost of capital of the three MDFA divisions. The Ventilation Division likely has a higher cost of capital since its products are sold primarily to private sector companies with greater exposure to the business cycle. In comparison, the Surfaces Division likely has a lower cost of capital as it sells its products primarily to city and municipal governments with relatively stable tax revenues and public works budgets. To be more precise, Denison decided to use divisional costs of capital to evaluate each project. To determine the cost of capital for the Ventilation Division, Denison collected information on five public companies in the industry: Company Beta Treasury Spread Rapid Flow 4.12% Environmental Systems 1.25 3.91 Clean Air 1.37 4.01% Circuvent 1.42 4,08% Pure Air 1.29 4025 For the Surfaces Division, MDFA only has one publicly-traded North American company for comparison. Dura Surface Ltd. has been in existence for 30 years selling road and sidewalk surfacing machinery. Exhibit I provides share prices for Dura Surface and national stock index values for the last five years. Dura Surface issues bonds to finance its operations, which currently trade at 101.11 and have a coupon rate of 5.31% and a term of 15 years. Due to its strong financial position, MDFA is able to raise new capital inexpensively. The cost of issuing new equity is 5.0% and the cost of raising debt is 1.5%. Company policy is not to include issuance costs in the costs of capital, but to show it as a cash outflow in all NPV analyses. Retained earnings are used instead of new equity to fund growth to avoid control problems. The interest rate on the 20-year Government of Canada bond is currently 4.0% and the market risk premium is 5.5%. MDFA has a marginal tax rate of 25.0% and a long-term debt to total capitalization ratio of 35.0% which approximates the company's target capital structure. Industrial Air Filtration System (IAFS) Projections The Ventilation Division will manufacture the IAFS using idle facilities. This plant can produce up to 200 units per year over the product's 10-year life. An outside appraiser indicated that the plant is worth CAD 2,750,000, which breaks down as CAD 1,250,000 for the land and CAD 1,500,000 for the building. New production equipment costing CAD 5,300,000 is also required. It is believed that the land will have a residual value of CAD 1,500,000 at the end of the project's life, while the building and equipment will be worth CAD 350,000 and CAD 250,000. The building is subject to a CCA rate of 4.0% and the equipment is subject to a CCA rate of 20.0%. Incremental net working capital of CAD 550,000 is also needed which will be liquidated at the end of the product's life. APSI sales are estimated to be 75 units in the first year and will grow by 25.0% a year until plant capacity is reached. The unit price is CAD 125,000 and unit costs are CAD 103,500 per unit, which includes direct materials, direct labour, and manufacturing overhead. The Ventilation Division must also pay a CAD 10,000 licensing fee per unit for the vacuum cleaner technology. Incremental selling and administration costs will be CAD 360,000 per year. Discount Rate In the past, MDFA used a corporate cost of capital to evaluate the feasibility of its new product proposals. Denison felt this rate was inaccurate as it reflected the weighted-average cost of capital of the three MDFA divisions. The Ventilation Division likely has a higher cost of capital since its products are sold primarily to private sector companies with greater exposure to the business cycle. In comparison, the Surfaces Division likely has a lower cost of capital as it sells its products primarily to city and municipal governments with relatively stable tax revenues and public works budgets. To be more precise, Denison decided to use divisional costs of capital to evaluate each project. To determine the cost of capital for the Ventilation Division, Denison collected information on five public companies in the industry: Company Beta Treasury Spread Rapid Flow 4.12% Environmental Systems 1.25 3.91 Clean Air 1.37 4.01% Circuvent 1.42 4,08% Pure Air 1.29 4025 For the Surfaces Division, MDFA only has one publicly-traded North American company for comparison. Dura Surface Ltd. has been in existence for 30 years selling road and sidewalk surfacing machinery. Exhibit I provides share prices for Dura Surface and national stock index values for the last five years. Dura Surface issues bonds to finance its operations, which currently trade at 101.11 and have a coupon rate of 5.31% and a term of 15 years. Due to its strong financial position, MDFA is able to raise new capital inexpensively. The cost of issuing new equity is 5.0% and the cost of raising debt is 1.5%. Company policy is not to include issuance costs in the costs of capital, but to show it as a cash outflow in all NPV analyses. Retained earnings are used instead of new equity to fund growth to avoid control problems. The interest rate on the 20-year Government of Canada bond is currently 4.0% and the market risk premium is 5.5%. MDFA has a marginal tax rate of 25.0% and a long-term debt to total capitalization ratio of 35.0% which approximates the company's target capital structure
