Felicia & Fred's executive board have asked you to complete a decision model for their intended refurbishment of the former mill building. In order to make an appropriate decision, the executive team has provided you with the following information regarding WACC and cash flows. It is your job to calculate the decision rules for NPV and IRR given the information provided.
Requirements:
1. Determine the target weighted average cost of capital for Felicia & Fred, given following assumptions:
Weights of 30% debt and 70% common equity (no preferred equity)
A 35% tax rate
The cost of debt is 9%
The beta of the company is 1.2
The risk free rate is 2%
The return on the market is 12%
Use the CAPM for calculation of the cost of equity.
2. Calculate the cash flows of the project given the following assumptions:
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 five 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%, a reduced rate that reflects a tax credit due to the repurpose of the building
Compute net present value and internal rate of return of the project. You may use Excel to complete this project. The text has a number of resources that provide examples of spreadsheet solutions for this purpose. Model your responses according to these examples.
Also, provide a 250-500 word executive summary on the results of the decision rule. Would you recommend that Felicia & Fred move forward with this project based on the NPV and IRR rules and outcomes? Why or why not? Consider any qualitative aspects of the decision as well. Provide a response with quantitative details which will be presented for consideration at the next executive board meeting.
For additional details, please refer to the Short Paper/Case Study Rubric document in the Assignment Guidelines and Rubrics section of
the course.