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Following is an example from my study guide which I need assistance solving in order to complete similar problems for this week's assignments.
1. You are asked to evaluate a new product line. From talking with the engineering, marketing, and tax departments, as well as the vendors and banks, you arrive at the following assumptions:
1. Use the company's cost of capital as the appropriate discount rate for the project cash flows.
2. The combined federal and state tax rate is 38.5%.
3. The prime rate is 8.25%.
4. The machinery invoice is $25 million, including transportation and installation.
5. Depreciation on the machinery is 20 years. Use straight line.
6. The total market for the product is $350 million (Yr. 1), and expected to grow at a 10% annual rate over the next five years.
7. Your company anticipates gaining an average 1% of the total market share the first year, 5% of the total market share the second year, and 8% of the total market share the third year. After year 3 the line will be salvaged and a new facility is planned to incorporate economies of scale.
8. Administrative and operating expenses are estimated to be 40% of annual gross revenues.
9. The firm has an outstanding bond issue that matures in 15 years, has a coupon of 7% (paid semiannually), and is priced at $913.54 (based on $1,000 par).
10. You expect a continued average growth rate as reflected in the company's last five years of dividend payments: Year 1-$1.50 dividend; Year 2-$1.65 dividend; Year 3-$1.85 dividend; Year 4-$2.00 dividend; and Year 5-$2.08 dividend (the next dividend is Year 6).
11. The current price of common stock is $36.75. Flotation costs on a new issue would be 8% of the share price.
12. The company has outstanding preferred stock with an 8.25% dividend selling for $108.50 ($100 par). Flotation costs on a new issue would be 5% of the share price.
13. The company is capitalized as follows: 45% debt, 10% preferred, 45% common stock (assume no retained earnings).
14. The salvage value at the end of three years is estimated to be $22.5 million. Tax rate is 38.5%.
15. Any losses can be used against other gains in the company for tax purposes.
Find/give: (1) the WACC, (2) the discounted payback, (3) the NPV, (4) the IRR, and (5) the modified IRR along with your recommendation on the capital project.
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