ABC Enterprise is considering the purchase of a new assembly line, costing $300,000. The new assembly line has a 5-year tax life and will be depreciated under straight-line. The firm estimates that in 4 years the assembly line can be salvaged for $40,000. For the next 4 years the new assembly line will increase output and thereby raises sales by $15,000 per year and will reduce production expenses by $5,000 per year. The firm also needs an initial decrease in net working capital of $20,000. Assume that 10 ABC’s tax rate is 34% and ABC Enterprise has the following information on its equity and bonds:
Common stock: 2 million shares outstanding, currently selling for $30 per share. ABC Enterprise expects to pay dividend of $3.00 next year and the dividend growth rate is expected to be 5%.
Bonds: 80,000 bonds outstanding, $1,000 face value for each bond, 7% coupon with 10 years to maturity, and selling for $1,150.00. The bonds pay coupons semi annually.
ABC Enterprise plans to raise the funds needed to purchase the assembly line by issuing new common stocks and bonds. The flotation costs of the new common stock would be 8% of the amount raised. The flotation costs of the new bonds would be 4% of the proceeds.
(a) What is the WACC of ABC Enterprise? (b) (10 points) What is the NPV of the project?