Capital Budgeting Case - From the given case information, calculate the firm's WACC then use the WACC to calculate NPV and evaluate IRR for proposed capital budgeting projects with a capital rationing constraint. After you choose the project(s), recalculate the capital structure based on the assumption that the project(s) are implemented and determine if the new capital structure will signal the investors either positively, negatively, or not at all. Write a business report on your findings. Include an executive summary and appendices if applicable.
Problem: Case information for business report:
North Sea Oil has complied the following data relative to current costs of its basic sources of external capital, long-term debt, preferred stock, and common stock equity.
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Source of Capital
|
Cost
|
|
Long-Term Debt
|
7%
|
|
Preferred Stock
|
19%
|
|
Common Stock and Retained Earnings
|
20%
|
Below are the company's target capital structure proportion used in calculating the weighted average cost of capital.
|
Source of Capital
|
Target Capital Structure
|
|
Long Term Debt
|
.25
|
|
Preferred Stock
|
.25
|
|
Common Stock and Retained Earnings
|
.50
|
North Sea Oil has the opportunity to invest in the following projects:
|
|
Project A
|
Project B
|
|
Initial Investment
|
$130,000
|
$85,000
|
|
Year
|
Cash Inflows
|
Cash Inflows
|
|
1
|
$25,000
|
$40,000
|
|
2
|
$35,000
|
$35,000
|
|
3
|
$45,000
|
$30,000
|
|
4
|
$50,000
|
$10,000
|
|
5
|
$55,000
|
$5000
|
Using WACC to calculate the NPV and evaluate the IRR, which project should be implemented? (You may also wish to include Payback to further support your answer).
Assuming the project(s) is implemented using, equity financing, the capital structure changes to:
|
Source of Capital
|
New Capital Structure after project implementation
|
|
Long Term Debt
|
.20
|
|
Preferred Stock
|
.20
|
|
Common Stock and Retained Earnings
|
.50
|
Calculate the New WACC and briefly discuss in your report if this new WACC and capital structure might signal the market and investors.