1) Calculate the new WACC
We are told:
Weights of 70% debt and 30% common equity (no preferred equity); this essentially reverses their previously calculated capital structure
A 35% tax rate
The cost of debt is now 9% due to an additional default risk premium
The beta of the company is 1.3
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
And we need to remember that market risk premium = Return on Market - Risk free rate
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 ) and remember to calculate the cost of debt as Cost od debt*(1-Tax rate)
2) Calculate the cash flows for the new crystal jewelry project given the following assumptions:
Initial investment outlay of $25 million, comprised of $20 million for machinery with $2 million for net working capital for metal inventory and $3 million for crystals
Project and equipment life is 5 years
Revenues are expected to increase $25 million annually
Gross margin percentage is 40% (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 35%
Compute net present value and internal rate of return of the project
3) Calculate the cash flows for the new crystal jewelry project given the same assumptions in part 2 but considering a 3 year option