WACC
| Short Paper Part 1 | ||||||||
| 1) Calculate the WACC | ||||||||
| We are told: | ||||||||
| Weights of 30% debt and 70% common equity (no preferred equity) | ||||||||
| A 35% tax rate | ||||||||
| The cost of debt is now 9% | ||||||||
| The beta of the company is 1.2 | ||||||||
| The risk free rate is 2% | ||||||||
| The return on the market is 12% | ||||||||
| First calculate the expected cost of equity determined using the CAPM: | ||||||||
| CAPM = Risk Free Rate + Equity Beta * Market Risk Premium | ||||||||
| 0.14 | ||||||||
| market risk premium = Return on Market – Risk free rate | ||||||||
| 0.1 | ||||||||
| So | ||||||||
| CAPM = Rrf + (beta*(retrurn on market – Rrf) | ||||||||
| Next calculate the WACC of the firm: | ||||||||
| WACC = (Weight Debt * Cost of Debt) + (Weight Equity * Cost of Equity ) | ||||||||
| Cost of debt*(1-Tax rate) | ||||||||
| 5.85% | ||||||||
| WACC | 11.56% | |||||||
| Part 2 | ||||||||
| Initial investment outlay of $60 million, comprised of $50 million for machinery with $10 million for net working capital (metal and gemstone inventory) | ||||||||
| Project and equipment life is 5 years | ||||||||
| Revenues are expected to increase $50 million annually | ||||||||
| Gross margin percentage is 60% (not including depreciation) | ||||||||
| Depreciation is computed at the straight-line rate for tax purposes | ||||||||
| Selling, general, and administrative expenses are 5% of sales | ||||||||
| Tax rate is 30% | ||||||||
| Compute net present value and internal rate of return of the project | ||||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | Comments | |
| Revenues | 50 | 50 | 50 | 50 | 50 | 50 M per year | ||
| Gross Margin | 30 | 30 | 30 | 30 | 30 | 60% of revenues | ||
| Sales & Admin | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | 5% of revenues | ||
| Depreciation | 50 | 50 | 50 | 50 | 50 | 50 million over 5 years | ||
| NWC Increase | -10 | 10 million out year 0 | ||||||
| NWC Recovery | 10 | 10 million recovered end of project | ||||||
| Capital Expenditures | -60 | 50 million | ||||||
| FCF | -70 | 34.25 | 34.25 | 34.25 | 34.25 | 44.25 | FCF=((Gross Margin-Sales&Admin)*(1-tax rate))+(Depreciation*tax rate)-NWC Increase – Capex + NWC recovery at end of project | |
| Tax | 30% | |||||||
| Discount Rate | 26.60% | |||||||
| NPV | Use NPV Formula | = CFo + (NPV(WACC,FCF1,FCF2,FCF3,FCF4,FCF5) | 22.24 | |||||
| IRR | Use IRR formula =IRR(Cfo:Cf5) | 41% | ||||||
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