Capital Co Has A Capital Structure Based On Current Market V
Capital Co Has A Capital Structure Based On Current Market Values T
Capital Co. has a capital structure, based on current market values, that consists of 42 percent debt, 13 percent preferred stock, and 45 percent common stock. If the returns required by investors are 10 percent, 11 percent, and 18 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent.
Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 91 percent as high if the price is raised 9 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year?
Bell Mountain Vineyards is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would save the company money, the cost of the system continues to decline. The Bell Mountain’s opportunity cost of capital is 16.7 percent, and the costs and values of investments made at different times in the future are as follows: Year Cost Value of Future Savings (at time of purchase) 0 $5,000 $7,300 7 $6,000 $7,900 14 $7,200 $7,500 21 $7,000 $8,000 Calculate the NPV of each choice. (Round answers to the nearest whole dollar, e.g., 5,275.) The NPV of each choice is:
Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. This investment will require an initial outlay of $12.20 million. The farm’s purchase includes $2.90 million for land and $9.30 million for trucks and equipment. At the end of 10 years, the land, trucks, and equipment are expected to be sold for $5.14 million, which is $2.26 million above book value. The farm is projected to generate revenue of $2.03 million annually, with operational cash flows totaling $1.89 million per year. The marginal tax rate is 35 percent, and the discount rate is 9 percent. Calculate the NPV of this project.
Paper For Above instruction
Financial decision-making involves various critical components such as capital structure analysis, project evaluation through net present value (NPV) calculations, and understanding the impact of pricing and operational changes on free cash flow (FCF). This paper explores these aspects, demonstrating their importance in strategic financial management and investment appraisal.
Calculating the Weighted Average Cost of Capital (WACC)
The weighted average cost of capital (WACC) is an essential metric that represents a firm's average after-tax cost of capital, considering the proportional weight of each component—debt, preferred stock, and common equity. For Capital Co., these proportions are 42% debt, 13% preferred stock, and 45% common stock, with respective required returns of 10%, 11%, and 18%. The firm's marginal tax rate is 40%, which affects the after-tax cost of debt calculation.
To compute WACC, the following formula is used:
WACC = (E/V) Re + (D/V) Rd (1 - Tc) + (P/V) Rps
Where:
- E/V = proportion of equity (common stock)
- D/V = proportion of debt
- P/V = proportion of preferred stock
- Re = cost of common equity
- Rd = cost of debt
- Rps = cost of preferred stock
- Tc = corporate tax rate
Substituting the values:
WACC = 0.45 0.18 + 0.42 0.10 (1 - 0.40) + 0.13 0.11
= 0.081 + 0.0252 + 0.0143 = 0.1205 or 12.05%.
Thus, Capital Co.'s after-tax WACC is approximately 12.05%, reflecting the firm's cost of capital considering its capital structure and tax effects.
Impact of Price Increase on Firm’s FCF
Chip's Home Brew Whiskey's analysis of price change impacts involves calculating changes in revenue, variable costs, fixed costs, and taxes to determine net effect on Free Cash Flow (FCF). The initial demand at a price of $20 per bottle is 15,000 units, with a decrease in demand of 9% if the price is increased by 9%.
New price: $20 * 1.09 = $21.80
New demand: 15,000 * 0.91 = 13,650 bottles
Revenue: 13,650 * $21.80 = $297,570
Variable costs: 13,650 * $10 = $136,500
Contribution margin: $297,570 - $136,500 = $161,070
Fixed costs: $100,000
Operational income before taxes: $161,070 - $100,000 = $61,070
Tax (30%): $61,070 * 0.30 = $18,321
Net operating income: $61,070 - $18,321 = $42,749
Add back depreciation: $20,000 (non-cash expense)
Change in working capital: increase by $3,000
FCF calculation:
FCF = Net income + Depreciation - Increase in working capital
FCF = $42,749 + $20,000 - $3,000 = $59,749
The price increase results in an additional FCF of approximately $59,749 for the year, illustrating how strategic pricing impacts operational cash flows.
NPV Calculation for Investment Choices
The Net Present Value (NPV) method assesses the profitability of capital investments by discounting expected cash inflows and outflows to their present value. The opportunity cost of capital, or discount rate, is critical in evaluating these projects.
For the company evaluating electronic system upgrades, each investment's initial cost is compared with the present value of expected future savings, discounted at 16.7%.
Example calculation:
- Year 0: Cost = $5,000; Future savings = $7,300
- NPV = -$5,000 + ($7,300 / (1 + 0.167)^0) = -$5,000 + $7,300 = $2,300
The calculations for each subsequent investment period follow similarly, discounting future benefits to present value and subtracting the initial cost. Options with positive NPVs will justify investment; those with negative NPVs should be avoided.
This approach aids firms in selecting projects that maximize value and aligns investment with strategic financial goals.
NPV for Acquisition of Farm Investment
The evaluation of the farm investment considers initial costs, ongoing revenues, operational costs, tax implications, and salvage value. The key is determining the present value of future cash flows, including terminal value from asset liquidation.
Initial investment: $12.20 million
Annual revenues: $2.03 million, with operational cash flows of $1.89 million, are used to calculate taxable income and taxes:
Taxable income = $1.89 million
Taxes = 35% of $1.89 million = $661,500
Net income: $1.89 million - $661,500 = $1,228,500
Operational cash flows: $1.89 million + Depreciation (assuming non-cash expense, not specified here) = approximately $1.89 million, adjusted for taxes.
Terminal value includes selling the land and assets at the end of the period:
Salvage value: $5.14 million, with a tax impact of lifetime capital gains.
Calculating NPV involves discounting these cash flows at 9% and subtracting initial costs, providing a comprehensive measure of project viability.
Overall, a positive NPV indicates the investment's potential to add value, guiding strategic operational decision-making for the firm.
Conclusion
Effective financial analysis requires integrating multiple tools and considerations, including WACC, FCF projections, project NPVs, and strategic timing of investments. Understanding these components enables firms to optimize capital structure, evaluate investment opportunities accurately, and make informed decisions that enhance shareholder value. Employing rigorous analytical techniques ensures resources are allocated efficiently, risks are managed appropriately, and long-term financial stability is maintained.
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