# Capital Budgeting project

1. Find the costs (rate of return under current market conditions) of the individual capital components.a. Long-term debt:
PV = -\$874.78, FV = \$1,000, PMT = \$100, n = 15, i = need to solve for this first
Kd = i (1-T)
Kd = i% (1 – .40)
Kd = i% (.60)
Kd = 6.94%

b. Preferred stock:
Kp = Dp / (Pp – F)
Kp = Hint: D is *\$100 par value times 9%
Kp = 10.35%

c. Retained earnings (avg. of CAPM and bond yield + risk premium approaches):
CAPM:15.76%
Kj = Rf + ß(Km – Rf)

Bond yield = 7.09% (calculated above) + 5% risk premium
= 16.56%
Average of two approaches: 15.76 + 16.56 / 2 = 16.16%

d. New common stock:
Kn = D1 / (P0 – F) + g
Kn = 17.40%

2. Compute the value of the long-term elements of the capital structure, and determine the target percentages for the optimal capital structure (based on current market value).

a. Long-term debt:
Market value = # bonds (bond price) = \$140,000,000
b. Preferred stock:
Market value = # shares (share price) = \$9,000,000
c. Common equity (retained earnings):
Market value = # shares (share price) = \$52,486,800

Long-term debt
52,486,800
26.0497%
Preferred stock
9,000,000
4.4668%
Common equity
140,000,000
69.4835%
Total capital (check figure)
\$201,486,800
100%

Determining the Marginal Cost of Capital:

Last year’s sales:
225,000,000
Net profit margin:

Net earnings:

Dividend payout ratio:
50%
New retained earnings in year 0:
*
*The firm also expects \$10 million in retained earnings in year 1

Retained earnings breakpoint:
X = Retained earnings / % of retained earnings in the capital structure
X =
Weighted Average Cost of Capital for Financing up to \$14 million:

Cost (aftertax)
Weights
Weighted Cost
Debt
Kd

69.4835

Preferred stock
Kp

4.4668

Retained earnings
Ke

26.0497

Weighted average cost of capital
Ka

Weighted Average Cost of Capital for Financing over \$14 million:

Cost (aftertax)
Weights
Weighted Cost
Debt
Kd

Preferred stock
Kp

New common stock
Kn

Weighted average cost of capital
Ka

3. Compute the Year 0 investment for Project I.
\$ (equipment) + \$ (installation) + \$ (AR/Inventory – Working capital) =

Year 0 Investment = \$15,000,000 + \$2,000,000 + \$4,000,000
Year 0 Investment = \$21,000,000

4. Compute the annual operating cash flows for years 1-6 of the project.
Annual depreciation expense:
Year
Depreciation Base
Percentage Depreciation
Annual Depreciation
1
\$17,000,000*
.2
3,400,000
2
17,000,000
.32
5,400,000
3
17,000,000
.192
3,264,000
4
17,000,000
.115
1,955,000
5
17,000,000
.115
1,955,000
6
17,000,000
.058
986,000

Total Depreciation
17,000,000\$
*MACRS is calculated with the purchase price as the depreciation base (Block et al., 2011).
Annual operating cash flows generated by the project:

Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Rev
\$5,000,000
\$10,000,000
\$14,000,000
\$16,000,000
\$12,000,000
\$8,000,000
FC
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
VC*
1,500,000
3,000,000
4,200,000
4,800,000
3,600,000
2,400,000
Depr**
3,400,000
5,400,000
3,264,000
1,955,000
1,955,000
986,000
EBT
(900,000)
560,000
5,536,000
8,245,000
5,445,000
3,614,000
Taxes‡

224,000
2,214,4000
3,298,000
2,178,000
1,445,600
EAT
(900,000)
336,000
3,321,600
4,947,000
3,267,000
2,168,400
+Depr
3,400,000
5,400,000
3,264,000
1,955,000
1,955,000
986,000
CF
2,500,000
5,776,000
6,585,600
6,902,000
5,222,000
3,154,400
*Revenues multiplied by 30%
**Calculated above
‡With a 40% tax rate

5. Compute the additional non-operating cash flow at the end of year 6.
Purchase price of equipment: -17,000,000

Total depreciation to date: 17,000,000

Book value: \$0.00

Sales price: \$4,000,000

Gain on sale:

Tax expense (40%): -1,600,000

Cash inflow from sale: 2,400,000

Recovery of working capital:

Total terminal cash inflow: 6,400,000

*(Hodges, n.d.).

6. Compute the IRR and payback period for Project I.
Payback period:
Year
Cash Inflows
1
2,500,000
2
5,776,000
3
6,585,600
Total
14,861,600

Investment to be recovered: 21,000,000

Less: Amount recovered by the end of year 3: 14,861,600

Amount still needed: 6,138,400

Divided by: Cash flow in year 4: 6,902,000

Fraction of year 4 needed to recover balance: 3.89

Payback period: = 3.89

Internal rate of return:
Using a financial calculator as explained on page 327 of our text:
CFo
(21,000,000)
CFj-1
2,500,000
CFj-2
5,776,000
CFj-3
6,585,600
CFj-4
6,902,000
CFj-5
5,222.000
CFj-6*
9,554,400
IRR
15.82%
*Operating cash flow of \$3,108,000 + Non-operating cash flow of \$6,400,000

7. Determine your firm’s cost of capital (WACC plus an adjustment for the write up).
Long term debt 6.94%
Common stock 17.40%
Preferred stock 10.35%

6.94% x 26.0497% + 17.40% x 69.4835% + 10.35% x 4.4668% = 14.36%

8. Compute the NPV for Project I. Should management adopt this project based on your analysis Explain. Would your answer be different if the project were determined to be of average risk Explain.

Using a financial calculator as explained on page 325 of our text:
CFo

CFj-1

CFj-2

CFj-3

CFj-4

CFj-5

CFj-6*

i

NPV

CFo

CFj-1

CFj-2

CFj-3

CFj-4

CFj-5

CFj-6*

i

NPV

*Operating cash flow of \$3,108,000 + Non-operating cash flow of \$6,400,000

Project I

9. Indicate which of the other projects (A through E) should be accepted and why.
Assuming these projects are not mutually exclusive, the company should accept both Project A and Project B.

References
Block, B. B., Hirt, G. A., & Danielsen, B. R. (2011). Foundations of financial management (14th ed.). New York, NY: McGraw-Hill/Irwin.
Hodges, C. W. (n.d.). Relevant capital budgeting cash flows are future. Retrieved from http://www.westga.edu/~chodges/pdf/capbudhint.pdf

# Our Service Charter

1. ### Excellent Quality / 100% Plagiarism-Free

We employ a number of measures to ensure top quality essays. The papers go through a system of quality control prior to delivery. We run plagiarism checks on each paper to ensure that they will be 100% plagiarism-free. So, only clean copies hit customers’ emails. We also never resell the papers completed by our writers. So, once it is checked using a plagiarism checker, the paper will be unique. Speaking of the academic writing standards, we will stick to the assignment brief given by the customer and assign the perfect writer. By saying “the perfect writer” we mean the one having an academic degree in the customer’s study field and positive feedback from other customers.
2. ### Free Revisions

We keep the quality bar of all papers high. But in case you need some extra brilliance to the paper, here’s what to do. First of all, you can choose a top writer. It means that we will assign an expert with a degree in your subject. And secondly, you can rely on our editing services. Our editors will revise your papers, checking whether or not they comply with high standards of academic writing. In addition, editing entails adjusting content if it’s off the topic, adding more sources, refining the language style, and making sure the referencing style is followed.
3. ### Confidentiality / 100% No Disclosure

We make sure that clients’ personal data remains confidential and is not exploited for any purposes beyond those related to our services. We only ask you to provide us with the information that is required to produce the paper according to your writing needs. Please note that the payment info is protected as well. Feel free to refer to the support team for more information about our payment methods. The fact that you used our service is kept secret due to the advanced security standards. So, you can be sure that no one will find out that you got a paper from our writing service.
4. ### Money Back Guarantee

If the writer doesn’t address all the questions on your assignment brief or the delivered paper appears to be off the topic, you can ask for a refund. Or, if it is applicable, you can opt in for free revision within 14-30 days, depending on your paper’s length. The revision or refund request should be sent within 14 days after delivery. The customer gets 100% money-back in case they haven't downloaded the paper. All approved refunds will be returned to the customer’s credit card or Bonus Balance in a form of store credit. Take a note that we will send an extra compensation if the customers goes with a store credit.
5. ### 24/7 Customer Support

We have a support team working 24/7 ready to give your issue concerning the order their immediate attention. If you have any questions about the ordering process, communication with the writer, payment options, feel free to join live chat. Be sure to get a fast response. They can also give you the exact price quote, taking into account the timing, desired academic level of the paper, and the number of pages.

Excellent Quality
Zero Plagiarism
Expert Writers

or

Instant Quote