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.
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.
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.