Instructions:
Using the company information provided below, complete the following two tabs in this MS Excel Workbook:
- Computation of the company's estimated cost of equity capital, rE, and weighted average cost of capital, rWACC
- NPV (capital budgeting) analysis of the company's proposed investment in a new Product B
The background paper, Capital Budgeting and the Cost of Capital, provides useful guidance for completing this assignment.
Based on the results of your NVP Analysis, summarize your recommendations to management regarding its contemplated introduction of the new product. Limit the length of your response to 75 words.
Company information:
North American Manufacturing Company is a U.S.-based publicly traded company, whose stock is listed on a national securities exchange.
Management looked up the stock's historical β (beta) at a popular financial Web search engine and obtained this additional information:
| Historical β (beta) of the company's common stock |
1.20 |
|
| Current market interest rate on the company's new borrowings, rD |
0.095 |
(9.5 percent) |
| Company's combined effective income tax rate, t |
0.400 |
(40.0 percent) |
| Management's estimate of the expected rate of return on the "market portfolio," rM |
0.125 |
(12.5 percent) |
| Management's estimate of the risk-free interest rate, rF |
0.040 |
(4.0 percent) |
The balance sheet of the company as of its most recent fiscal year end reflects management's targeted capital structure for the company.
That balance sheet reports the following liability and shareholders' equity balances:
| Notes payable to banks - current portion |
$ 10,000,000 |
| Bonds payable - current portion |
65,000,000 |
| Notes payable to banks - noncurrent portion |
375,000,000 |
| Bonds payable - noncurrent portion |
150,000,000 |
| Common stock, at par |
30,000,000 |
| Additional paid-in capital |
285,000,000 |
| Treasury stock |
(45,000,000) |
| Retained earnings |
$ 130,000,000 |
Instructions: Use the information in the first worksheet tab (Instructions and company/product information) to complete this tab. For each of a. through c., below, show all computations in good form and label properly all amounts presented.
a. Compute American Manufacuring Company's estimated cost of equity capital, rE
b. Compute the company's targeted capital structure (relative proportions of debt and common equity capital).
c. Compute the company's estimated weighted average cost of capital, rWACC
Proposal for New Product B - Computation of Projected Proceeds and Capital Gain Tax from Assumed End-of-Investment Sale of M&E
(A) Projected fair value of M&E in final period of NPV analysis (assumed gross proceeds) $-
(B) Original cost (taxable basis) of M&E
(C) Cumulative allowable "cost recovery" through final period of NPV analysis
(D) Adjusted taxable basis of M&E
(E) Taxable "capital gain"
(F) Combined effective income tax rate
(G) Income tax on "capital gain"
(H) Projected net proceeds from assumed end-of-investment sale of M&E $-
Attachment:- capital_budget_edwards.xls