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You will assume that you still work as a financial analyst for Aero Plain,

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You will assume that you still work as a financial analyst for Aero Plain, Inc. The company is;considering a capital investment in a new machine and you are in charge of making a;recommendation on the purchase based on (1) a minimum rate of return of 15% (Task 4) and;(2) the firms cost of capital (Task 5).;P;ART II;Task 4;Task 5;Here is how you will be graded;Assessing loan options;Step 1: Calculate IRR;Step 2: Calculate NPV;Step 3: Decision;Step 4: Explain how depreciation will affect the NPV;Step 5: Provide examples of at least one of the following;A. Sunk cost;B. Opportunity cost;C. Erosion;Step 6: Explain how you would conduct a scenario and sensitivity analysis;Cost of Capital;Step 1: Cost of Debt;A. What dies a price of 110.9 mean?;B. What is the dollar amount of market price?;C. What is the YTM of the competitors bond?;Screen Shot;D. Calculate the ATK;E. Why use the YTM and not the coupon rate;Step 2: Cost of Common Equity;A. Compute the cost of common equity using the CAPM;Screen Shot;B. Compare/contrast the CAPM with the dividend growth model (DGM);Step 3: Cost of Preferred Equity;A. Compute cost of Preferred Equity using the DGM with no growth;B. Other methods to compute the Cost of Preferred Equity;Step 4: Calculate WACC;Step 5: Should the firm use this WACC for all projects;Step 6: Re-compute the NPV of the project above using this WACC. Would you;change your earlier recommendation? Explain.;TOTAL;Possibl;e;15;15;5;5;5;5;5;10;2;2;2;4;5;5;6;4;10;10;5;10;10;10;150;Earned;Task 4. Capital Budgeting for a New Machine;A few months have now passed and Aero Plain, Inc. is considering the purchase on a new;machine that will increase the production of a special component significantly. The anticipated;cash flows for the project are as follows;Year 1;$1,100,000;Year 2;$1,300,000;Year 3;$950,000;Year 4;$1,400,000;You have now been tasked with providing a recommendation for the project based on the;results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the;initial cost of the machine is $3,500,000.;1. What is the projects IRR? Show your calculations and display your answer to the;nearest TWO decimal places (like this: 12.34%). (15 pts);2. What is the projects NPV? Show your calculations and display your answer to the;nearest TWO decimal places (like this: 12.34%). (15 pts);3. Should the company accept this project and why (or why not)? (5 pts);4. Explain how depreciation will affect the present value of the project. (5 pts);5. Provide examples of the following as each relates to the proposed project: (5 pts each);a. Sunk Cost;b. Opportunity cost;c. Erosion;6. Explain how you would conduct a scenario and sensitivity analysis of the project. What;would be some project-specific risks and market risks related to this project? (10 pts);Task 5: Cost of Capital;Aero Plain, Inc. is now considering that the appropriate discount rate for the new machine;should be the cost of capital and would like to determine it. You will assist in the process of;obtaining this rate.;1. Compute the cost of debt. Assume Aero Plain, Inc. is considering issuing new bonds.;Select current bonds from one of its main competitors, Raytheon, Boeing, Lockheed;Martin, and the Northrop Grumman Corporation as a benchmark return for the new;bonds.;You may use a number of sources to get bond information about a comparable;firm to use as a benchmark. We recommend Morningstar. But Morningstar is a;little difficult to navigate so you will find it much easier to search directly from your;search engine (Google or Yahoo) for the desired firms bonds and selecting;Morningstar from the list of web pages. Here is a sample of the correct page for;an unrelated company, Briggs & Stratton (BBG), manufacturer of Simplicity;garden tractors.;Scroll down to see a list of bonds issued by your benchmark company.;Briggs has only issued one bond which matures in 2020. The aerospace firm;you select will have many. Select the one with the longest maturity date. You;may assume that new bonds issued by Aero Plain, Inc. are of similar risk and will;require the same return.;a. What is the coupon rate of the Briggs & Stratton Bond? (2 pts);b. What is the Yield to Maturity of the Briggs & Stratton Bond? (2 pts);c. Include a screen shot of the bond page of the competitor selected. (4 pts).;d. What is the YTM of the competitors bond you have selected? (2 pts);e. What is the after-tax cost of debt if the tax rate is 30%? Show your;calculations and display your answer to the nearest TWO decimal places (like;this: 12.34%). (5 pts);f.;Explain why you should use the YTM and not the coupon rate as the required;return for debt. (5 pts);2. The cost of common equity may be derived using the CAPM model. For beta, use the;average beta of three competitor competitors. You may obtain the betas from LexisNexis;(in the course Home tab, select Student Resources, then select Library, Databases;then LexisNexis.) You can also get the information you need from Google Finance or;Yahoo Finance.;a. Assume the risk free rate to be 3.5% and the average market return to be 6.5%.;Using the CAPM model, what is the cost of common equity? Include a screen;shot of the page from which you observed the required data and show your;calculations. Display your answer to the nearest TWO decimal places (like this;12.34%).. (10 pts);b. Explain the advantages and disadvantages to use the CAPM model as the;method to compute the cost of common equity. Compare and contrast this;method with the dividend growth model approach. (10 pts);3. One method to calculate the required rate of return on preferred stock is to use the;Gordon Model, also called the Dividend Growth Model. But with preferred stock;dividends are always the same and never change. The growth factor is, therefore, zero.;a. Using the dividend growth model with zero growth, assuming the dividend paid;on preferred stock is $2.50 and the current value of the stock is $62 per share;compute the cost of preferred equity. Show your calculations and display your;answer to the nearest TWO decimal places (like this: 12.34%). (10 pts);b. What other means could we use to compute the cost of preferred equity?;Explain. (5 pts);4. Assuming that the market value weights of these capital sources are 30% bonds, 50%;common equity and 20% preferred equity, what is the weighted cost of capital of the;firm? Show your calculations and display your answer to the nearest TWO decimal;places (like this: 12.34%). (10 pts);5. Should the firm use this WACC for all projects? Explain and provide examples as;appropriate. (10 pts);6. Re-compute the net present value of the project using the cost of capital you found in;Task 5 Question 4 above. Do you still believe that your earlier recommendation for;accepting or rejecting the project was adequate? Why or why not? Show your;calculations. (10 pts)

 

Paper#29859 | Written in 18-Jul-2015

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