CAPITAL BUDGETING PROJECT

Capital Budgeting Project



Capital Budgeting Project

These data, calculations, and information relate to a company who is planning to evaluate a new project given its financial position. The paper first provides the basis of other projects in the table. Following this, we present the cost of equity, debt and preferred stock. Then a 5 step process leads us to conclude whether the company should invest in the new project 'I' or not.

Project

Cost

IRR

A

17,000,000

21%

B

21,000,000

19%

C

16,000,000

15%

D

28,000,000

11%

E

25,000,000

8%

1. Cost of Equity, Debt, and Preferred Stock

 

Number

Value

Coupon % /Dividend $

Annual Cost

Cost up to Maturity

Cost of Long Term Debt

60,000

870.73

0.09

9403884

141058260

 

 

 

 

 

 

Cost of Preferred stock

100,000

94

7.8

780000

indefinite

Number of Shares

Market Price

Growth Rate (Annual)

Last Dividend

New Dividend (Expected)

Total

Cost of Equity

10000000

15

0.08

0.9

0.972

9720000

Using the above table the cost of equity (stated in percentage) will be computed from the following formula:

Cost of Equity = D0 / P0 * 100

Cost Equity = 0.9 / 15

Cost of Equity = 0.06 or 6%

Cost of Debt = Bond Value * Coupon Rate * Number of Bonds

Cost of Debt = 870.73 * 0.09 * 60,000

Cost of Debt = 9403884 Annually

2. Determine the weighted average cost of capital. (5 points)

This equation implies that:

WACC = (percent of the firm that is equity) times (cost of equity) plus (percent of the firm that is debt) times (cost of debt)

WACC

Cost of Equity

+

Cost of Debt

WACC

52.5*(0.28)

+

47.5*0.09

WACC

0.147

+

0.04275

WACC

 

0.18975

 

3. Compute the Year 0 investment for Project I. (5 points)

Year 0 Investment

$

Equipment

17,000,000

Installation Costs

1,000,000

Total

18,000,000

4. Compute the annual operating cash flows for years 1-6 of the project. (20 points)

Year

Cash flows

Fixed Costs

Variable Costs (30%)

Annual Operating Cash Flow

1

6,000,000

1000000

1800000

3,200,000

2

14,000,000

1000000

4200000

8,800,000

3

15,000,000

1000000

4500000

9,500,000

4

16,000,000

1000000

4800000

10,200,000

5

11,000,000

1000000

3300000

6,700,000

6

8,000,000

1000000

2400000

4,600,000

5. Compute the non-operating (terminal) cash flow at the end of year 6. (10 points)

Salvage Value

5,000,000

6. Draw a timeline that summarizes all of the cash flows for your venture. (5 points)

Year

0

1

2

3

4

5

6

NCF

(18,000,000)

5,000,000

8,800,000

9,500,000

10,200,000

6,700,000

4,600,000

7. Compute the IRR, payback, ...