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Assignment 1: LASA # 2?Capital Budgeting Techniques A+




Question;As a financial consultant, you have contracted with Wheel Industries;to evaluate their procedures involving the evaluation of long term;investment opportunities. You have agreed to provide a detailed report;illustrating the use of several techniques for evaluating capital;projects including the weighted average cost of capital to the firm, the;anticipated cash flows for the projects, and the methods used for;project selection. In addition, you have been asked to evaluate two;projects, incorporating risk into the calculations.;You have also agreed to provide an 8-10 page report, in good form;with detailed explanation of your methodology, findings, and;recommendations.;Company Information;Wheel Industries is considering a three-year expansion project;Project A. The project requires an initial investment of $1.5 million.;The project will use the straight-line depreciation method. The project;has no salvage value. It is estimated that the project will generate;additional revenues of $1.2 million per year before tax and has;additional annual costs of $600,000. The Marginal Tax rate is 35%.;Required;Wheel has just paid a dividend of $2.50 per share. The;dividends are expected to grow at a constant rate of six percent per;year forever. If the stock is currently selling for $50 per share with a;10% flotation cost, what is the cost of new equity for the firm? What;are the advantages and disadvantages of using this type of financing for;the firm?;The firm is considering using debt in its capital structure. If the;market rate of 5% is appropriate for debt of this kind, what is the;after tax cost of debt for the company? What are the advantages and;disadvantages of using this type of financing for the firm?;The firm has decided on a capital structure consisting of 30% debt;and 70% new common stock. Calculate the WACC and explain how it is used;in the capital budgeting process.;Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.;If the discount rate were 6 percent calculate the NPV of the;project. Is this an economically acceptable project to undertake? Why or;why not?;Now calculate the IRR for the project. Is this an acceptable;project? Why or why not? Is there a conflict between your answer to part;C? Explain why or why not?;Wheel has two other possible investment opportunities, which are;mutually exclusive, and independent of Investment A above. Both;investments will cost $120,000 and have a life of 6 years. The after tax;cash flows are expected to be the same over the six year life for both;projects, and the probabilities for each year's after tax cash flow is;given in the table below.;Investment B;Investment C;Probability;After Tax Cash Flow;Probability;After Tax Cash Flow;0.25;$20,000;0.30;$22,000;0.50;32,000;0.50;40,000;0.25;40,000;0.20;50,000;What is the expected value of each project?s;annual after tax cash flow? Justify your answers and identify any;conflicts between the IRR and the NPV and explain why these conflicts;may occur.;Assuming that the appropriate discount rate for projects of this;risk level is 8%, what is the risk-adjusted NPV for each project? Which;project, if either, should be selected? Justify your conclusion.;Correctly;calculated the cost of new equity and explained the calculations, as;well as the advantages and disadvantages of using this type of financing;for the firm. (CO4);20;Correctly calculated the cost of new debt;and explained the calculations, as well as the advantages and;disadvantages of using this type of financing for the firm. (CO4);20;Correctly calculated the weighted average;cost of capital and explained how and why it is used in the capital;budgeting process. (CO4);20;Correctly calculated the annual cash flows for the projects and explained the methods used in the calculations. (CO1);44;Evaluated the projects using the NPV method and came to the correct conclusions based on the decision rules for the NPV. (CO2);44;Evaluated the projects using the IRR;method and came to the correct conclusion based on the decision rules;for the IRR. Identified any conflicts between the IRR and the NPV and;explained why these conflicts may occur. (CO 3);44;Correctly introduced risk into the;evaluation by using the expected values as the cash flows and evaluated;these cash flows using risk adjusted discounted rates. (CO 5);44;Written in a clear, concise, and;organized manner, demonstrated ethical scholarship in accurate;representation and attribution of sources, displayed accurate spelling;grammar, and punctuation.;64;Total;300


Paper#51607 | Written in 18-Jul-2015

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