PROBLEM 1 - NPV and Weighted Average Cost of Capital
Hilliard Corp. wants to calculate its weighted average cost of capital (WACC). The company's CFO has collected the following information:
- The company's long-term bonds currently offer a coupon of 7 percent and were sold at par value.
- The company's stock price is $35 per share.
- The Risk-free rate is currently 3%
- The company's seeks to havea Debt/Equity ratio of 2/3.
- The company's tax rate is 35%.
- The industry Beta is 1.20.
- The Market Return is 9.5%.
Part 1. What is the company's WACC?
Part 2: Next, Assume Hilliard is considering the replacement of one of its machines. The project's risk is similar to the firm's average operations. The old machine is being depreciated by the straight-line method over a 10-year recovery period from a depreciable cost basis of $120,000. The old machine has 5 years of remaining usable life, at which time its salvage value is expected to be zero, and it can be sold now for $40,000. This machine has a current book value of $60,000, so a $20,000 capital loss will be incurred on the sale.
The purchase price of the new machine is $200,000. It has a 5-year life and an expected salvage value of $25,000. Annual savings of electricity, labor, and materials from use of the new machine are estimated at $50,000. The company is in a 35 percent federal-plus-state tax bracket. The MACRS depreciation method will be used and the recovery percentages for assets with a 5-year class life are given below:
|
Year
|
Recovery Allowance Percentage
|
|
1
|
20%
|
|
2
|
32
|
|
3
|
19
|
|
4
|
12
|
|
5
|
11
|
|
6
|
6
|
|
|
100%
|
Guiding Questions:
a. What is the initial net cash outlay if we move forward and buy the new machine?
b. Illustrate the cash flows from assets (OCF, NCS, changes in NWC) using a time line?
c. What is the cash flow from salvage value in Year 5?
d. Determine cash flows from assets (CFFA) in Years 1-5
e. Should the new machine be purchased? Why or Why Not?
Problem 2: Mergers
T-Mobile and Sprint are talking about a Merger! Most Mergers do not add value - so why is this merger being considered.
- Discuss the benefits (synergies) related to this merger and provide your opinion of whether or not you believe each of the synergies will be realized.
- If you were involved in this Merger what difficulties (potential pitfalls) do you believe T-mobile and Sprint need to pay special attention to in order to be successful?
- What issues could keep this Merger from proceeding?
- Do you believe this is a "good" merger? Why?