CAPITAL BUDGETING FINAL EXAM
ACMC Inc. is a multinational conglomerate corporation providing a wide range of goods and services to its customers. As part of its budgeting process for the next year, it has three mutually exclusive projects under consideration, and it might decide which project should receive the investment funds for this year.
As part of the financial analysis team, it is up to you to determine the appropriate
valuation of each project. However, before you can determine the appropriate valuations of these projects, you need to determine the weighted average cost of capital for the firm. Do remember that management has a preference in using the market values of the firm’s capital structure and believes it current structure is optimal.
BALANCE SHEET
Cash 2,000,000
Accounts Payable and Accruals 18,000,000
Accounts Receivable 28,000,000
Notes Payable 40,000,000
Inventories 42,000,000
Long-Term Debt 60,000,000
Preferred Stock 10,000,000
Net Fixed Assets 133,000,000
Common Equity 77,000,000
Total Assets 205,000,000
Total Claims 205,000,000
Market Values of Capital
• The company has 60,000 bonds with a 30-year life outstanding, with 15 years until
maturity. The bonds carry a 10 percent semi-annual coupon, and are currently selling for $874.78.
• You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock
outstanding. The current market price is $90.00.
• The company has 5 million shares of common stock outstanding with a currently
price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80.
• The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22.
• Your firm does not use notes payable for long-term financing.
• Your firm’s federal + state marginal tax rate is 40%.
Project A:
This project requires an initial investment of $20,000,000 in equipment which will cost an additional $3,000,000 to install. The firm will use the attached MACRS depreciation schedule to expense this equipment. Once the equipment is installed, the company will need to increase raw goods inventory by $5,000,000, but it will also see an increase in accounts payable for $1,500,000. With this investment, the project will last 6 years at which time the market value for the equipment will be $1,000,000.
The project will project a product with a sales price of $20.00 per unit and the variable cost per unit will be $10.00. It is estimated the sales volume for this project will be 700,000 in year 1, 1,000,000 in year 2, 650,000 in year 3, 700,000 in year 4, 650,000 in year 5 and 550,000 in year 6. The fixed costs would be $2,000,000 per year. Because this project is very close to current products sold by the business, management has expressed some favoritism towards this project and as allowed for a reduced rate of return of 2 percentage point below its current WACC as the valuation hurdle it must meet or surpass.
