Cost of Capital, Capital Structure, and Capital Budgeting Analysis
1. Purpose of the project:
In this project, you are supposed to be a financial manager to apply the knowledge obtained from the financial management course to determine the cost of debt, cost of preferred stock, cost of common equity, capital structure, and the weighted average cost of capital (WACC) for a publicly-traded corporation of your choice. You will use the estimated WACC as the discount rate to conduct capital budgeting analysis for a hypothetical project (the information given below) that is under consideration by the selected company, and decide whether the project should be accepted.
2. Outline for the project:
(1) Executive Summary
- Summarize the major findings, results, and the analysis of the report.
(2) Financial Ratio Analysis
You are expected to apply the knowledge obtained in Financial Management and Financial Statement Analysis to the key financial ratios of the selected company.
- Perform trend analysis of the key financial ratios (i.e., liquidity ratios, asset management ratios, debt management ratios, profitability ratios, market value ratios) of the company.
- Perform industry (or benchmark companies) comparison analysis of the key financial ratios of the company.
- Based on the financial ratio analysis results, discuss/evaluate the financial performance of the company.
(3) Estimate Capital Structure
- Estimate the firm's weights of debt, preferred stock, and common stock using the firm's balance sheet (book value).
- Estimate the firm's weights of debt, preferred stock, and common stock using the market value of each capital component.
(4) Compute Weighted Average Cost of Capital (WACC)
- Estimate the firm's before-tax and after-tax component cost of debt; (Note: If the information about the current corporate tax rate is not available, you need to estimate the tax rate based on the historical tax payments).
- Estimate the firm's component cost of preferred stock;
- Use three approaches (CAPM, DCF, bond-yield-plus-risk-premium) to estimate the component cost of common equity of the firm.
- Calculate the firm's weighted average cost of capital (WACC) using market-based capital weights.
(5) Cash Flow Estimation
- We assume that the company you selected is considering a new project. The project has 8 years life. This project requires initial investment of $300 million to construct building and purchase equipment, and $20 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of the fixed assets is $15 million. The number of units of the new product expected to be sold in the first year is 2,000,000 and the expected annual growth rate is 10%. The sales price is $300 per unit and the variable cost is $220 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.8%. The required net operating working capital (NOWC) is 12% of sales. Please use the corporate tax rate that you obtained in Step (4) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Note: you may revise the partial model in the file FM12 CH12 P11 Build a Model. xls on the website of the textbook (also posted in this project learning module) for capital budgeting analysis, but you are NOT required to strictly follow the partial model. Actually, you are encouraged to build a better model by yourself.
- Compute the depreciation basis and annual depreciation of the new project. (Please refer to Table 11A-2 MACRS allowances on PP.469)
- Estimate annual cash flows for the 8 years.
- Draw a time line of the cash flows.
(6) Capital Budgeting Analysis
- Using the WACC you obtained from in Step (4) as the discount rate for this project, apply capital budgeting analysis techniques (NPV, IRR, MIRR, PI, Payback, Discounted Payback) to analyze the new project.
- Perform asensitivity analysis for the effects of key variables (e.g., sales growth rate, cost of capital, unit costs, sales price) on the estimated NPV or IRR in order to demonstrate the sensitivity of the model. The Scenario analysis of several variables simultaneously is encouraged, but not required. A PDF document named Sensitivity Analysis in Excel is provided in this learning module. The article introduces the Data Table method that you can use for performing sensitivity analysis in Excel.
- Discuss whether the project should be taken and summarize your report.
3. Other information regarding the project:
Your project should be well-organized and typed in a Word document and attach the important tables with your report. The style and organization of the project is also very important.
Attachment:- Build a model.rar