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Calculate Cash Flows, WACC, IRR & Payback Period

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Here is the company's balance sheet:


Cash- $2,000,000

Accts. Receivable- $28,000,000

Inventories- $42,000,000

Net Fixed Assets- $133,000,000

Total Assets- $205,000,000


Accts. Payable- $18,000,000

Notes Payable- $40,000,000

Long-Term Debt- $60,000,000

Preferred Stock- $10,000,000

Common Equity- $77,000,000

Total Liabilities- $205,000,000

Other Info:

Last Year's Sales- $225,000,000

- The Company has 60,000 bonds with a 30-year life outstanding, with 15 years till maturity. The bonds carry a 10% semi-annual coupon and are currently selling for $874.78.

- They also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share float cost.

-They have 10 million shares of common stock outstanding with a current price of $14.00 a share. The stock exhibits a constant growth rate of 10%. The last dividend(Do) was $.80. New stock could be sold with flotation costs, including market pressure, of 15%.

-The risk free rate is currently 6% and the rate of return on the stock market as a whole is 14%. The company stock's beta is 1.22.

-Stockholders require a risk premium of 5% above the return on the firms bonds.

-The firm expects to have additional retained earnings of $10 million in the coming year and expects a depreciation expenses of $35 million.

-The firm does not use notes payable for long-term financing.

-The firm considers its market value capital structure to be optimal and wishes to maintain that structure.

-The firm's federal+state marginal tax rate is 40%.

-The firm's dividend payout ration is 50% and net profit margin was 8.89%.

You are pitching a new product to your company. You estimate that the product will have a six-year life span, and the equipment used to manufacture the product falls in the MACRS 5-year class. Your venture would require a capital investment of $15,000,000 in equipment, plus $2,000,000 in installation costs. The venture would also result in an increase of accounts recievable and inventories of $4,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $4,000,000 salvage value.

Your venture, which management considers fairly risky, would increase fixed costs by a constant $1,000,000 per year while variable costs of the venture would equal 30% of the revenues. You are projecting that revenues generated by the product would equal %5,000,000 in year 1, $10,000,000 in year 2, $14,000,000 in year 3, $16,000,000 in year 4, $12,000,000 in year 5, and $8,000,000 in year 6.

The firm's management requires a 2% adjustment to the cost of capital for risky projects.

The cost of individual capital components are:

1. long-term debt: 7.09%
2. preferred stock: 10.34%
3. retained earnings: 16.29%
4. new common stock: 17.39%

Calculate the following:

A.) Compute the WACC twice, once using retained earnings as Re and the next using new common stock's cost for Re, then determine which WACC is best

B.) Compute the Year 0 investment for the project

C.) Compute cash flows for years 1-6

D.) Compute the additional non-operating cash flow at the end of year 6

E.) Compute the IRR and payback period for the project

F.) Add the cash flows up and determine PV

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Solution Preview

Please see the attachment.

A.) Compute the WACC twice, once using retained earnings as Re and the next using new common stock's cost for Re, then determine which WACC is best

WACC = Proportion of debt X after tax cost of debt + Proportion of preferred stock X cost of preferred stock + Proportion of common stock X cost of common stock
The cost is given to us and the proportions are based on market values. We first ...

Solution Summary

The explains how to calculate the cash flows and determine the WACC, IRR, payback period, year 0 investment and PV for the given case.