Your Probationary Period At Cosmo K Manufacturing Group

Question

Your Probationary Period At The Cosmo K Manufacturing Group Continues Your probationary period at the Cosmo K Manufacturing Group continues. For this week's project, Gerry has asked you to consider two mutually exclusive investments and incorporate risk considerations into the process of evaluation. The Cosmo K Manufacturing Group is considering the addition of a new smelting machine or a new paving machine. The two investments are mutually exclusive; if one is selected, the other is rejected. The annual cash flows after taxes and the effects of depreciation, which begin one year from project start, and their respective probabilities are given below: Smelting Machine | Probability | Net Cash Flows per Year | |--------------|-------------------------| | 0.2 | $14,100.00 | | 0.5 | $16,000.00 | | 0.2 | $17,000.00 | | 0.1 | $20,000.00 | Paving Machine | Probability | Net Cash Flows per Year | |--------------|-------------------------| | 0.2 | $2,000.00 | | 0.5 | $16,000.00 | | 0.2 | $22,000.00 | | 0.1 | $33,000.00 | Each project has an expected life of 4 years and will cost $45,000. The riskier project will be evaluated at the company's WACC plus 3%, and the less risky project at the company's WACC. Cosmo K has the following capital structure: debt (30%), preferred stock (16%), and common stock (54%). All new debt will be raised via long-term bonds with a coupon rate of 13%. The company's common stock is priced at $65 per share, paid a dividend of $4.25 last year, with an expected growth rate of 6%. Preferred stock can be sold for $90 per share, pays a dividend of $10, with $2 floatation costs per share. The current market risk premium is 5%, the risk-free rate is 8%, and Cosmo K's beta is 1.23. The corporate tax rate is 40%. Tasks: - Calculate the component cost of capital using CAPM. - Determine the company's WACC. - Compute the expected cash flows for each investment. - Calculate the standard deviation for each investment. - Determine the coefficient of variation for

Dr. Jack HW Helper · Accepted Answer

Introduction The assessment of investment projects is a fundamental component of corporate financial management, requiring careful analysis of expected returns, risks, and strategic fit. This paper evaluates two mutually exclusive investment opportunities—adding a new smelting machine and a new paving machine—for the Cosmo K Manufacturing Group. The analysis incorporates calculation of the component cost of capital, weighted average cost of capital (WACC), expected cash flows, risk measures including standard deviation and coefficient of variation, and financial appraisal techniques such as NPV and IRR. The goal is to determine the more suitable investment considering risk-adjusted returns and strategic objectives. Component Cost of Capital using CAPM The Capital Asset Pricing Model (CAPM) estimates the cost of equity as follows: $$ Cost\,of\,Equity = R_f + \beta (Risk\,Premium) $$ where: - $ R_f $ (Risk-free rate) = 8% - $ \beta $ = 1.23 - Market risk premium = 5% Calculating: $$ Cost\,of\,Equity = 8\% + 1.23 \times 5\% = 8\% + 6.15\% = 14.15\% $$ The component cost of preferred stock ( $ r_{ps} $ ): $$ r_{ps} = \frac{D_{ps}}{P_{ps, net}} = \frac{10}{90 - 2} = \frac{10}{88} \approx 11.36\% $$ The component cost of debt ( $ r_d $ ), considering tax shield: $$ r_{d} = 13\% $$ Adjusted for tax: $$ r_{d, after-tax} = 13\% \times (1 - 0.40) = 7.8\% $$ The weighted component costs are: $$ W_{d} = 30\%,\, W_{ps} = 16\%,\, W_{cs} = 54\% $$ Thus, the component costs are: - Debt: 7.8% - Preferred stock: 11.36% - Equity: 14.15% The weighted average cost of capital (WACC): $$ WACC = W_d \times r_{d, after-tax} + W_{ps} \times r_{ps} + W_{cs} \times r_{e} $$ $$ WACC = 0.30 \times 7.8\% + 0.16 \times 11.36\% + 0.54 \times 14.15\% \approx 2.34\% + 1.82\% + 7.64\% = 11.80\% $$ (Further sections include detailed expected cash flows calculations, risk assessments through statistical measures, project evaluations via NPV and IRR, and strategic recommendations based on the ana

Your Probationary Period At Cosmo K Manufacturing Group ✓ Solved

Your Probationary Period At The Cosmo K Manufacturing Group Continues

Sample Paper For Above instruction

Introduction

Component Cost of Capital using CAPM

Conclusion

References