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The Campbell Company is a manufacture.

Their capital structure comprises

1. Long-Term debt, with an incremental borrowing rate of 8%

2. Capital stock, with the following information:

Risk free rate                    6%
Market rate of return         13%
Beta                               1.2
Long-Term debt            40% of sum financing
Capital Stock               60% of sum financing
The company’s tax rate is    40%

Required:

Using CAMP, evaluate the cost of equity financing

Evaluate the Weighted Average Cost of Capital

Analyze the subsequent 4 independent projects:

Use        NPV
             IRR
           Payback

To determine if the project must be accepted or rejected

IGNORE: Terminal cash flows and Working Capital needs. (Use 7 year depreciation table)

Use 7 year depreciation table (tax-depreciation)

Project 1

Purchase of capital equipment for expansion

Capital expenditure            1,000,000
Useful life 8 years
Pre-tax Cash flows (not including depreciation)

Year            Revenues            Costs
1                250,000            100,000
2                262,500            105,000
3                275,625            110,250
4                289,406            115,763
5                303,877            121,551
6                319,070            127,628
7                335,024            134,010
8                351,775            140,710
                 2,387,277         954,911
Project 2

Purchase of capital equipment for expansion

Capital expenditure            500,000

Useful life 8 years

Pre-tax Cash flows (not including depreciation)

Year            Revenues            Costs
1                 250,000            100,000
2                 262,500            105,000
3                 275,625            110,250
4                 289,406            115,763
5                 303,877            121,551
6                 319,070            127,628
7                 335,024            134,010
8                 351,775            140,710
                 2,387,277           954,911
Project 3

Purchase of capital equipment for replacement

Capital expenditure            1,000,000

Useful life 8 years

Pre-tax Cash flows (not including depreciation)

Year            Revenues            Costs
1                 200,000                -
2                 210,000                -
3                 220,500                -
4                 231,525                -
5                 243,101                -
6                 255,256                -
7                 268,019                -
8                 281,420                -
                  1,909,822              -
Project 4

Purchase of capital equipment for replacement

Capital expenditure            700,000

Useful life 8 years

Pre-tax Cash flows (not including depreciation)

Year            Revenues                Costs
1                      -                   (200,000)
2                      -                   (200,000)
3                      -                   (200,000)
4                      -                   (200,000)
5                      -                   (200,000)
6                      -                   (200,000)
7                      -                   (200,000)
8                      -                   (200,000)  
                        -                  (1,600,000)

*Suppose 200,000 is positive cash flow

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M91562

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