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You will assume that you still work as a financial analyst for AirJet Best Parts, Inc.




You will assume that you still work as a financial analyst for AirJet Best Parts, 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 given rate of return of 15% (Task 4) and (2);the firms cost of capital (Task 5).;Task 4. Capital Budgeting for a New Machine;A few months have now passed and AirJet Best Parts, 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;$1,450,000;Year 3;$1,300,000;Year 4;$950,000;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 $3,000,000.;1. What is the projects IRR? (10 pts);2. What is the projects NPV? (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. (10 pts);5. Provide examples of at least one of the following as it relates to the 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? (20 pts);Task 5: Cost of Capital;AirJet Best Parts 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 AirJet Best Parts Inc. is considering issuing new;bonds. Select current bonds from one of the main competitors as a benchmark. Key;competitors include Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman;Corporation.;a. What is the YTM of the competitors bond? You may use a number of sources;but we recommend Morningstar. Find the YTM of one 15 or 20 year bond with;the highest possible creditworthiness. You may assume that new bonds issued;by AirJet Best Parts, Inc. are of similar risk and will require the same return. (5;pts);b. What is the after-tax cost of debt if the tax rate is 34%? (5 pts);c. Explain what other methods you could have used to find the cost of debt for;AirJet Best Parts Inc.(10 pts);d. Explain why you should use the YTM and not the coupon rate as the required;return for debt. (5 pts);2. Compute the cost of common equity using the CAPM model. For beta, use the average;beta of three selected competitors. You may obtain the betas from Yahoo Finance.;Assume the risk free rate to be 3% and the market risk premium to be 4%.;a. What is the cost of common equity? (5 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. Compute the cost of preferred equity assuming the dividend paid for preferred stock is;$2.93 and the current value of the stock is $50 per share.;a. What is the cost of preferred equity? (5 pts);b. Is there any other method to compute this cost? Explain. (5 pts);4. Assuming that the market value weights of these capital sources are 30% bonds, 60%;common equity and 10% preferred equity, what is the weighted cost of capital of the;firm? (10 pts);5. Should the firm use this WACC for all projects? Explain and provide examples as;appropriate. (10 pts);6. Recompute the net present value of the project based on the cost of capital you found.;Do you still believe that your earlier recommendation for accepting or rejecting the;project was adequate? Why or why not? (5 pts);Make sure to provide a yes/no recommendation on the purchase of the new machine. Justify your;recommendation.;Grades will be determined by;Category;Points %;Task 4 Capital Budgeting 75;Task 5 Cost of Capital;75;Description;50;Compute the NPV and IRR of a project and;make recommendations based on calculations;(30 pts). Analyze factors affecting the capital;budgeting process (25 pts). Describe project;risks and analysis (20 pts).;50;Calculate the WACC and describe methods for;computing the cost of capital (60 pts). Explain;the appropriate use of the WACC (10 pts).;Compute the NPV of a project based on the;WACC (5 pts).;Category;Points %;Total;150;100


Paper#30360 | Written in 18-Jul-2015

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