Question
You are the head of the acquisitions department of a company. A potential investment in Peltier Devices, Inc (PDI) is currently under review. The following
You are the head of the acquisitions department of a company. A potential investment in Peltier Devices, Inc (PDI) is currently under review. The following information regarding the company is available. PDI is a private company that imports small dehumidifiers that remove excess moisture from the air, and sells them domestically. The product works well for small rooms and closets. The technology is based on the Peltier effect whereby an electrified junction between two materials emit or absorb heat, and is not proprietary. The firm has a first mover advantage, which will likely erode over time. The firm has been in operation for two years. Below is some information about the projections.
| Cash flow projections: | ||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | ||||||
| Future cash flows | $300 | $1,448 | $965 | $808 | $1,948 | |||||
| Assumptions: | ||||||||||
| Beta | 1.28 | |||||||||
| Cost of debt | 4% | |||||||||
| Market equity risk premium | 5% | |||||||||
| E/V | 80.00% | |||||||||
| D/V | 20.00% | |||||||||
| Risk-free rate | 3.00% | |||||||||
| Tax rate | 40% | |||||||||
| Terminal value* | $41,335 | |||||||||
| Terminal date | Year 5 | |||||||||
| Question 1 | ||||||||||
| Calculate the weighted average cost of capital (WACC) for PDI. | ||||||||||
| Question 2 | ||||||||||
| Calculate the discounted cash flow value for PDI. | ||||||||||
| Question 3 | ||||||||||
| Use your calculated answers to advise the board on the feasability of the investment by interpreting the results with reference to risk and return. (Max. 150 words) | ||||||||||
Answer : I am sharing the answer which i have prepared, Plese review / validate and guide
Answer # 1
| Calculate the weighted average cost of capital (WACC) for PDI. | ||||
| E/V | 80.00% | |||
| Cost of equity | 9.40% | |||
| Risk-free rate | 3.00% | |||
| Beta | 1.28 | |||
| Market equity risk premium | 5.00% | |||
| D/V | 20.00% | |||
| Cost of debt | 4.00% | |||
| Corporate tax rate | 40.00% | |||
| WACC | 8.0% | |||
Answer # 2
| Assumptions | ||||||
| Discount rate (calculated in answer to Question 1) | 8.00% | |||||
| Terminal value | $41,335 | |||||
| Free cash flow projection | ||||||
| Calculations End of Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
| Free cash flow | $300 | $1,448 | $965 | $808 | $1,948 | |
| Present value of FCF | $277.78 | $1,241.43 | $765.89 | $593.76 | $1,325.78 | |
| Sum of FCF PV | $4,204.63 | |||||
| Terminal value | ||||||
| Present value of terminal value | $28,131.91 | |||||
| Total value of PDI | $32,336.53 |
Answer # 3
[Based on the calculations, PDI's weighted average cost of capital (WACC) is 8%. This represents the average rate of return expected by investors for each dollar invested in the company. The discounted cash flow value for PDI is $32,336.53. This represents the estimated intrinsic value of the company based on its projected cash flows and the discount rate. Feasibility of the investment: Risk: The erosion of the first-mover advantage over time increases the risk for PDI. New competitors with similar products may reduce PDI's market share and profitability. Return: The projected cash flows indicate positive growth in the first few years and increasing cash flows. However, it's important to compare the expected return from the investment with the WACC. The investment may be considered feasible if the expected return is higher than the WACC. Overall, the feasibility of the investment depends on the board's risk appetite and return expectations. ] [149 words]
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started