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| Short Paper Part 1 | | | | | | | |
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| 1) Calculate the WACC | | | | | | | |
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| 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% | | | | | | | |
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| First calculate the expected cost of
equity determined using the CAPM: | | | | | |
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| 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) | | | | | | |
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| Next calculate the WACC of the firm: | | | | | | | |
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| WACC = (Weight Debt * Cost of Debt)
+ (Weight Equity * Cost of Equity ) | | | | | |
| Cost of debt*(1-Tax rate) | | | | | | | |
| 5.85% | | | | | | | |
WACC | 11.56% | | | | | | | |
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| Part 2 | | | | | | | |
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| 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% | | | | | | | |
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| Compute net present value
and internal rate of return of the project | | | | | |
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| Year | 0 | 1 | 2 | 3 | 4 | 5 | Comments |
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| 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 |
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| Tax | 30% | | | | | | |
| Discount Rate | 26.60% | | | | | | |
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| NPV | Use NPV Formula | = CFo + (NPV(WACC,FCF1,FCF2,FCF3,FCF4,FCF5) | 22.24 | | |
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| IRR | Use IRR formula =IRR(Cfo:Cf5) | | | 41% | | |
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