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Felicia & Fred

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Now that the board members of Felicia & Fred are planning to implement a new crystal jewelry product line, they are concerned about potential shareholder sentiment regarding the dilution of ownership interest. As a result of this, the board is giving consideration to a significant change in capital structure in order to raise the cash required to fund the project. This would change the current capital structure from 30% debt and 70% equity to 70% debt and 30% equity.

Although shareholder sentiment may be appeased by this approach, discuss the following considerations that may emerge as a result of this drastic change in capital structure from a qualitative perspective:

Question 1

What is the likely effect on the weighted average cost of capital?  Explain by example.

 
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The Gruman Company

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The Gruman Company purchased a machine for $ 220,000 on January 2, 2013. It made the following estimates:

Service life 5 years or 10,000 hours
Production 200,000 units
Residual value $ 20,000


In 2013, Gruman uses the machine for 1,800 hours and produces 44,000 units. In 2014, Gruman uses the machine for 1,500 hours and produces 35,000 units. If required, round your final answer to the nearest dollar.

Required:

  1. Compute the depreciation for 2013 and 2014 under each of the following methods:
    1. Straight-line method 
2013 $   
2014 $   
  • Sum-of-the-years’-digits method
2013 $   
2014 $   
  • Double-declining-balance method
2013 $   
2014 $   
  • Activity method based on hours worked
2013 $   
2014 $   
  • Activity method based on units of output
2013 $   
2014 $   
  • For each method, what is the book value of the machine at the end of 2013? At the end of 2014?
    • Straight-line method 
2013 $   
2014 $   
  • Sum-of-the-years’-digits method
2013 $   
2014 $   
  • Double-declining-balance method
2013 $   
2014 $   
  • Activity method based on hours worked
2013 $   
2014 $   
  • Activity method based on units of output
2013 $   
2014 $   
  • If Gruman used a service life of 8 years or 15,000 hours and a residual value of $10,000, what would be the effect on the following under the straight-line, sum-of-the-years’-digits, and double-declining-balance depreciation methods?

Depreciation expense

  1. Straight-line method 
2013 $   
2014 $   
  • Sum-of-the-years’-digits method
2013 $   
2014 $   
  • Double-declining-balance method
2013 $   
2014 $   

Book value 

  • Straight-line method 
2013 $   
2014 $   
  • Sum-of-the-years’-digits method
2013 $   
2014 $   
  • Double-declining-balance method
2013 $   
2014 $   
 
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NPV & IRR and outcomes

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Hi,

I need to write a paragraph or two explaining/recommending  a company to move forward or not with a refurbishment of a former mill building so the company can expand their manufacturing business. Would you recommend that the company move forward with this project based on the NPV & IRR and outcomes? Why or why not? 

NPV= 16.88Million

IRR= 20.35%

WACC= 11.56%

Consider any qualitative aspects of the decision as well. Provide a response with quantitative details which will be presented for consideration at the next executive board meeting. 

 
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WACC

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Short Paper Part 1 
1) Calculate the WACC
We are told:
Weights of 30% debt and 70% common equity (no preferred equity)
A 35% tax rate
The cost of debt is now 9% 
The beta of the company is 1.2
The risk free rate is 2%
The return on the market is 12%
First calculate the expected cost of equity determined using the CAPM: 
 
CAPM = Risk Free Rate + Equity Beta * Market Risk Premium
0.14
market risk premium = Return on Market – Risk free rate
0.1
So
CAPM = Rrf + (beta*(retrurn on market – Rrf)
 
Next calculate the WACC of the firm:
WACC = (Weight Debt * Cost of Debt) + (Weight Equity * Cost of Equity )
Cost of debt*(1-Tax rate)
5.85%
WACC11.56%
Part 2
Initial investment outlay of $60 million, comprised of $50 million for machinery with $10 million for net working capital (metal and gemstone inventory)
Project and equipment life is 5 years
Revenues are expected to increase $50 million annually
Gross margin percentage is 60% (not including depreciation)
Depreciation is computed at the straight-line rate for tax purposes
Selling, general, and administrative expenses are 5% of sales
Tax rate is 30%
Compute net present value and internal rate of return of the project
Year012345Comments
Revenues505050505050 M per year
Gross Margin303030303060% of revenues
Sales & Admin2.52.52.52.52.55% of revenues
Depreciation505050505050 million over 5 years
NWC Increase-1010 million out year 0
NWC Recovery1010 million recovered end of project
Capital Expenditures-6050 million 
FCF-7034.2534.2534.2534.2544.25FCF=((Gross Margin-Sales&Admin)*(1-tax rate))+(Depreciation*tax rate)-NWC Increase – Capex + NWC recovery at end of project
 
Tax30% 
Discount Rate26.60%
NPVUse NPV Formula  = CFo + (NPV(WACC,FCF1,FCF2,FCF3,FCF4,FCF5)22.24   
IRR Use IRR formula  =IRR(Cfo:Cf5)41% 
  
  
      
 
 
 
 
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