Posted: July 5th, 2024

Capital budgeting techniques

Question description

Unit 5: Module 5 - M5 Assignment 1
 
Assignment 1: LASA # 2—Capital Budgeting Techniques
By Saturday, February 1, 2014, submit the following assignment:
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.

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Investment B

Investment C

Probability

After Tax
Cash Flow

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Probability

After Tax
Cash Flow

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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
conclusions. Turn in your completed work to the M5: Assignment 1 Dropbox by Saturday, February 1, 2014.
Assignment 1 Grading Criteria

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Maximum Points

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)

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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)

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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)

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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.

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64

Total:

300

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