In this project, you are supposed to be a financial manager working for a big corporation, 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 company of your choice. You will use the WACC as the discount rate to conduct capital budgeting analysis for a project that the firm is considering and then decide whether it should be accepted or not. Assume the project under consideration has similar risk as your chosen public company so that you can use the cost of capital as the discount rate for this project.
II. Outline for the project:
(1) Executive Summary
(2) Component cost of capital estimation:
A: Estimate your firm’s approximate cost of debt.
B: Estimate your firm’s approximate Cost of equity
(3) Estimate capital structure and WACC:
A. Estimate the weights of debt, and common stock in the capital structure using your chosen company’s balance sheet (book value).
B. Estimate the firm's:1’s weights of debt and common stock using the market value of each capital component.
C. Estimate the firm’s after-tax cost of debt. (Cost of debt is estimated above (2)).
D. Calculate the firm’s weighted average cost of capital (WACC) using both book weights and market Weights.
(4) 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 $125 million to purchase land, construct building, and purchase equipment, and $8.5 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of fixed assets is $35 million. The number of units of the new product expected to be sold in the first year is 700,000 and the expected annual growth rate is 7%. The sales price is $220 per unit and the variable cost is $145 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 3%. The required net operating working capital (NOWC) is 11% of sales. The company is in the 40% tax bracket. The project is assumed to have the same risk as the corporation. 7
A: Compute the depreciation basis and annual depreciation of the new project.
B: Estimate annual cash flows for the 8 years.
C: Draw a timeline of the cash flows.
(5) Capital Budgeting Analysis:
A: Using the WACC you obtained in (3) above for your chosen publicly-traded company as the discount rate for the project, apply capital budgeting analysis techniques (NPV, IRR,) to analyze the new project.
B: Perform a sensitivity analysis for the effects of key variables (sales growth rate, cost of capital, sales price) on the estimated NPV or IRR in order to demonstrate the sensitivity of the model.
C: Discuss whether the project should be taken.