Determining cost of capital and project risk

Assignment Help Finance Basics
Reference no: EM1330864

Cascade Water Company (CWC) currently has 30,000,000 shares of common stock out- standing that trade at a price of $42 per share. CWC also has 500,000 bonds outstanding that currently trade at $923.38 each. CWC has no preferred stock outstanding and has an equity beta of 2.639. The risk-free rate is 3.5%, and the market is expected to return 12.52%. The firm's bonds have a 20-year life, a $1,000 par value, a 10% coupon rate and pay interest semi-annually.

CWC is considering adding to its product mix a "healthy" bottled water geared toward children. The initial outlay for the project is expected to be $3,000,000, which will be depreciated using the straight-line method to a zero salvage value, and sales are expected to be 1,250,000 units per year at a price of $1.25 per unit. Variable costs are estimated to be $0.24 per unit, and fixed costs of the project are estimated at $200,000 per year. The project is expected to have a 3-year life and a terminal value (excluding the operating cash flows in year 3) of $500,000. CWC has a 34% marginal tax rate. For the purposes of this project, working capital effects will be ignored. Bottled water targeted at children is expected to have different risk characteristics from the firm's current products. Therefore, CWC has decided to use the "pure play" approach to evaluate this project. After researching the market, CWC managed to find two pure-play firms. The specifics for those two firms are:

Firm Equity Beta D/E Tax Rate
Fruity Water 1.72 0.43 34%
Ladybug Drinks 1.84 0.35 36%

1. Determine the current weighted average cost of capital for CWC.

2. Determine the appropriate discount rate for the healthy bottled water project.

3. Should the firm undertake the healthy bottled water project? As part of your analysis, include a sensitivity analysis for sales price, variable costs, fixed costs, and unit sales at ±10%, 20%, and 30% from the base case. Also perform an analysis of the following two scenarios:

a. Best Case: Selling 2,500,000 units at a price of $1.24 each, with variable production costs of $0.22 per unit.

b. Worst Case: Selling 950,000 units at a price of $1.32 per unit, with variable production costs of $0.27 per unit.

Reference no: EM1330864

Reviews

Write a Review

 

Finance Basics Questions & Answers

  Demand function has a negative slope

Over the past twenty years, the number of small family farms has fallen significantly also in their place there are fewer, but larger, farms owned by corporation.

  Computation of value of the bond and the total interest

Computation of value of the bond and What is the total interest expense recorded on these bonds over the fifteen years if the market rate of interest

  What is the maximum monthly charge cookie cutter

Illustrate what is the maximum monthly charge Cookie Cutter should pay for this lockbox system if the payment is due at the beginning of the month.

  Computation of break even points

Computation of break even points - What would the breakeven volume be at this new selling price?

  Computation of value of a bond using several required rate

Computation of Value of a Bond using various required rate of return using coupon rate maturing in 20 years for an investor whose required rate of return

  Detemining the value of share

XYZ has debt of 32,500,000 and is expected to produce FCF of 9,500,000 upcoming year. How do I compute the value of a share of XYZ if the company has 10 million shares outstanding.

  Present value of lump sum-stream of payments

How is present value of lump sum related to he present value of a stream of payments?

  Computing amount of semi-annual investment

Jean Cleveland currently has $5,750 in a money market account paying 5.65 percent compounded semi-annually. How much should she invest in money market account semi-annually over the next five years to achieve this target?

  Marriage penalty-life annuity taxation

Howard and Beatrice plan to marry either immediately before or immediately after year-end. Based on tax considerations, what marriage date would you suggest for loving couple? How much would your choice save in taxes?

  Effect of financial leverage

The Effect of Financial Leverage and working capital management

  Bonds nominal yield to maturity

What is the current yield on these bonds and  What is the bond's nominal yield to maturity.

  Explain capital budgeting involves calculation of npv

Explain Capital budgeting involves calculation of NPV and IRR and Which projects will the firm select for investment

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd