Question
You are making 10-year cash flow projections for an e-commerce company. Analysts estimate that the typical cost of debt for the e-commerce industry is approximately
You are making 10-year cash flow projections for an e-commerce company.
Analysts estimate that the typical cost of debt for the e-commerce industry is approximately 6%. The projected beta of equity for the project is 1.1, and the firm is planning to maintain a constant debt-to- equity ratio (in market values) of 0.3. Using expert forecasts for stock market returns, you believe that the annual expected return for the entire market will be 8% for the next 10 years, and that the risk-free rate will be projected to remain at 4% over the entire life of the project. Assume a marginal tax rate of 25%, and that any tax loss can be carried forward indefinitely.
The revenues from the project are expected to be $7.5 billion at the end of the first year, and are expected to grow at a rate of 10% per year. Labor is expected to cost approximately 10% of revenues every year, while COGS are estimated to be 15% of revenues each year.
The equipment needed for the project costs $3 billion, and according to the tax authority, is depreciated using the straight line method over ten years. You can operate the machinery for 10 years. The pre-tax salvage value of the machinery at the end of the 10 years is expected to be $500 million. The purchase of the machinery is made today.
You also expect to incur additional capital expenditures of $2 million for new computer equipment at the end of year 7. This equipment is depreciated using the straight line method over the remaining life of the project, and is not expected to have any salvage value.
The net working capital required for the project is given by the following data: days sales outstanding will be 30 days (out of a 360 day cycle) and based entirely on annual revenues, while days payable outstanding will be 30 days (out of a 360 day cycle), and will only be relevant for labor costs (not for COGS or any other expenses). Inventory will be 10% of COGS each year. Assume net working capital is 0 as of today, and fully recovered by the end of the project.
(a) Please calculate the weighted average cost of capital for the project.
(b) Please forecast the free cash flows for the project.
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