Assignment Task: Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations. Thus, the project will be assigned a discount rate equal to the firm's cost of capital plus 2.5 percent. The proposed project has an initial cost of $8.1 million that will be depreciated on a straight-line basis to a zero-book value over 6 years. The project also requires additional inventory of $228,000 over the project's life, which will return to original levels at the end of the project. Management estimates the facility will generate cash savings of $2.46 million a year over its 6-year life. After 6 years, the company plans to sell the facility for a cash value of $500,000. The company has 58,000 shares of common stock outstanding at a market price of $52 per share. This stock just paid an annual dividend of $2.84 a share. The dividend is expected to increase by 3.6 percent annually. The firm also has 15,000 shares of 9 percent preferred stock with a market value of $87 a share. The preferred stock has a par value of $100. The company has $1.2 million of $1,000 face value bonds with semiannual payments and a coupon rate of 9 percent. The bonds are currently priced at 102 percent of face value and mature in 13 years. The tax rate is 35%.
Should the firm pursue the expansion project at this point in time? Use NPV, IRR, and payback techniques to form your decision. The company usually expects a payback of three years unless the project is riskier than normal. Explain your answers, showing quantitative justification where appropriate.
Now, in a separate section of your spreadsheet, copying your original work, assume your cash savings is 10% lower than the projected $2.46 million. Recalculate the NPV, IRR, and Payback.
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