Question:
Instructions: This project requires you to apply the concepts and methods learned in the course. This is an individual project.
Assignment: You are interested in proposing a new venture to the management of your company. Pertinent financial information is given below.
Balance Sheet Data
Cash 3,000,000 Accounts Payable and Accruals 14,000,000
Accounts Receivable 24,000,000 Notes Payable 29,356,200
Inventories 55,000,000 Long-Term Debt (Bonds) 52,243,800
Preferred Stock 9,400,000
Net Fixed Assets 173,000,000 Common Stock (Equity) 150,000,000
Total Assets 255,000,000 Total Liabilities &
Owners' Equity 255,000,000
Last year's sales were $210,000,000.
The company has 60,000 bonds with a 30-year life outstanding, with 15 years until maturity. The bonds carry a 9 percent semi-annual coupon, and are currently selling for $870.73.
You also have 100,000 shares of perpetual preferred stock outstanding, which pays a dividend of $7.80 per share. The current market price is $94.00.
The company has 10 million shares of common stock outstanding with a current price of $15.00 per share. The stock exhibits a constant growth rate of 8 percent. The last dividend (D0) was $.90.
Your firm does not use notes payable for long-term financing.
The firm's target capital structure is 25% debt, 5% preferred stock, and 70% common equity. The firm does not plan to issue new common stock.
Your firm's federal + state marginal tax rate is 38%.
The firm has the following investment opportunities currently available in addition to the venture that you are proposing:
Project NPV IRR
A 5,000,000 20%
B 4,000,000 10%
C 3,500,000 15%
D 3,000,000 11%
E 2,000,000 8%
All projects, including Project I, are assumed to be of average risk. Your venture would consist of a new product introduction (You should label your venture as Project I, for "introduction"). You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 5-year class. The resulting MACRS depreciation percentages for years 1 through 6, respectively, are 20%, 32%, 19%, 12%, 11%, and 6%. Your venture would require a capital investment of $17,000,000 in equipment, plus $1,000,000 in installation costs.
The venture would also result in an increase in accounts receivable and inventories of $3,000,000. This means there is a change in NWC (cash outflow) at the start of the project. The NWC ($ 3,000,000) will be released as a cash inflow in Year 6.
At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $5,000,000 salvage value. Your venture would incur fixed costs of $1,000,000 per year, while the variable costs of the venture would equal 30 percent of revenues. You are projecting that revenues generated by the project would equal $6,000,000 in year 1, $14,000,000 in year 2, $15,000,000 in year 3, $16,000,000 in year 4, $11,000,000 in year 5, and $8,000,000 in year 6.
The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.
1. Find the costs of the individual capital components:
a. long-term debt
b. preferred stock
c. Common Stock (Equity) (use DCF approach)
2. Determine the weighted average cost of capital.
3. Compute the Year 0 investment for Project I.
4. Compute the annual operating cash flows for years 1-6 of the project.
5. Compute the non-operating (terminal Salvage and change in NWC) cash flow at the end of year 6.
6. Draw a timeline that summarizes all of the cash flows for your venture.
7. Compute the IRR, payback, discounted payback, and NPV for Project I.
8. Prepare a report for the firm's CEO indicating which projects should be accepted and why.
9. Conclude the project with your reflections on what you have learned from this course and how it has affected your view of your own job and career.