Capital budgeting and the cost of capital, Corporate Finance

Roman Roads has a number of capital projects available for investment this year but has access to a limited amount of capital.  Specifically, the firm has arranged to secure a $25 million bond sale with their investment bankers and has $84 million worth of retained earnings and remaining seed capital that its directors are prepared to re-invest into new opportunities.  They would like your advice on which projects they should pursue (all asset pools are quite large and would remain open after the projects are completed).

According to the firm's chief financial officer, Roman Roads has established its capital structure (target D/E ratio of 0.8) in line with the static trade-off theory so it should not be changed.  The $25 million in new bonds will be sold off with a 7.4% annual coupon rate for total floatation costs of 2.7% (Roman Roads is not very well known).  The firm's common stock trades on the TSX Venture Exchange for $14.60 per share but it pays no dividends.  Independent analysts have estimated that the company has a beta of 2.2 with the broader market, which is expected to return 10.65% over the long run.  Your best estimate for the average risk-free rate for the life of the projects 3.3%.  Roman Roads pays an average tax rate of 25%.

Project 1 - $32 million upfront cost, $7.3 million after-tax profits each year for 8 years, salvage for $4.2 million, CCA rate on assets = 20%

Project 2 - $22 million upfront cost, $5.8 million after-tax profits each year for 5 years, then $3.4 million after-tax profits for 4 more years.  salvage assets for $6 million, CCA rate = 8%

Project 3 - $44 million upfront cost, $10 million in yearly after-tax profits for 20 years, no salvage, $20 million maintenance expense every 5 years (not paid at the end of the project's life), CCA rate = 10%

Project 4 - $20 million upfront cost, $7.1 million in yearly after-tax profits for 3 years, salvage for $6.8 million, CCA rate on assets = 20%

Project 5 - $29 million upfront cost, $8.4 million in yearly after-tax profits for 6 years, salvage for $12 million, requires $4 million in working capital (only half is recovered at project's end), CCA rate = 15%

a)      How much money will Roman Roads actually get from selling $25 million worth of bonds to investors?

b)      If the capital structure is fixed, how much is Roman Roads' capital budget for the year?

c)      What cost of capital should be applied to these projects?

d)      Which of the 5 projects above should be pursued given the firm's budget restriction?

Posted Date: 2/23/2013 3:10:40 AM | Location : United States







Related Discussions:- Capital budgeting and the cost of capital, Assignment Help, Ask Question on Capital budgeting and the cost of capital, Get Answer, Expert's Help, Capital budgeting and the cost of capital Discussions

Write discussion on Capital budgeting and the cost of capital
Your posts are moderated
Related Questions
Question 1: (i) How do economists go about studying the economics of the public sector? Describe the four stages of analysis (ii) The level of government intervention dif

I need immediate assistance with a finance project. Could you help?

The East Coast Conglomerate Co (ECCC) a small manufacturing company is doing a risk management assessment and a total review of their insurance policies. They have asked you,  know

how can i rank a project when there are conflict between IRR & NPV

You are a ceo of a sotware firm that has limited access to debt equity markets. The average return on last year projects is 28 % . and cost of capital is 12%. would npv pr Irr be

Do mergers result in layoffs? A: Overall employment in the banking industry actually has increased slightly over the last ten years. Some mergers do result in layoffs. However,

Question: In view of its international operations management, Remo Ltd which is based in USA expects to make a payment of £ 50,000 to a UK supplier for raw materials in six mon

You are required to provide an essay or report of approx 500 words or less (excluding attachments and references),  accompanied by relevant calculations, in MS Word orPDF format ac

Question: (a) With the help of illustrative and numerical examples differentiate fully speculation and arbitraging in the context of foreign exchange. (b) Shirley, a trade

Question: A U.S company has a liability of € 10 million in fixed rate loans outstanding at 6%. A German company has a $15 million Floating Rate Note outstanding at LIBOR. The e