find the weighted average cost of capital , Econometrics

Assignment Help:

PrivateJets (PJ) is considering expanding its operations in the corporate travel market.

Currently, PJ has a capital structure with a 25% debt-equity ratio. Their levered equity has a β of 1.5; theirdebt has a β of 0.1. The risk-free rate is 5%, and the expected return on the market is 10%.

The proposed project is in the same line of business as existing operations, and is expected to generate cashflows over a period of 10 years. Annual expected pre-tax revenues would be $20 million (times 1 to 10).Annual expected pre-tax costs would be $8 million (times 1 to 10).

PJ currently leases planes to several small commuter airlines. PJ's analysis projects that if its corporate jetproject is successful, there will be less demand for these leases in the future. PJ's current lease contractsrun through year 5. PJ projects that the new contracts in year 6 will fall in value by $10 million (value atyear 6 of all the lost future after-tax cash flows) if the new project goes ahead.

PJ also projects that its current booking and sales capacity can handle the expanded operations through year 3, but in year 4 overhead expenses for the company will increase from $4 million per year to $5 million per year (and remain at that level through the rest of the project).The project will initially (year 0) require a working capital account of $4 million, which will have to beincreased to $6 million in year 4, and increased again to $8 million in year 8. The total amount in theworking capital account can be recovered in year 10 after the project is completed.

New planes will be purchased in year 0 at a total cost of $20 million. They can be depreciated over 5 yearsusing straight-line depreciation. At the end of the project, they would have an after tax market value of $11million in year 10. PJ can also use 2 of its existing planes starting in year 6 when their leases expire. Theseplanes are completely paid for and depreciated for tax purposes, and they could each be leased out for $1million per year (before taxes). At the end of this project, they will be returned to the leasing operation.

PrivateJets contracted with a consulting firm to analyze the market potential of the new project; the fee forthe report is $0.5 million. Their report has been completed and the first installment of the fee has been paid.An additional $0.25 million is due at time 1 (and the firm intends to make the payment and will notdefault). PJ pays a 35% marginal corporate tax rate.

a) Find the weighted average cost of capital (WACC).

b) Should PrivateJets proceed with the project? If the expansion is undertaken, how does it change the value of the firm?

c) Suppose that PrivateJets can spend an extra $0.25 million per year (years 1-10) onmaintenance of the newly-purchased planes described above. If it does so, the planes would retaintheir value and their after-tax market value in year 10 would be $20 million (instead of the $11million described above). What is the equivalent annual cost (or benefit) of increasing themaintenance? Should the firm undertake the higher maintenance schedule?


Related Discussions:- find the weighted average cost of capital

Crude oil, A shok question #Minimum 100 words accepted# when did...

A shok question #Minimum 100 words accepted# when did the most recent shock to the crude oil market occur

Public economics, Explain the stages and various coordination mechanisms in...

Explain the stages and various coordination mechanisms involved in policy processes. Discuss various factors that influenced the agenda setting in policy processes

Game theory, Students in the red/black card game had to make individual dea...

Students in the red/black card game had to make individual deals. How would the situation change if they could bargain collectively?

Total differential of the tr , A  firm's  total  revenue (TR)  is  prov...

A  firm's  total  revenue (TR)  is  provided by  pq, where  p  is  price  and  q  is  quantity sold. Assume the  firm  is  initially  selling  1000  units  of  its  product at  a

Diagnostic test, explanation on diagnostic test in time series

explanation on diagnostic test in time series

Elasticity, compare the price elasticity of demand on two parallel demand c...

compare the price elasticity of demand on two parallel demand curves for a given price and for a given quantity

Methodology, What methodology will be suitable to use for a doctoral resea...

What methodology will be suitable to use for a doctoral research proposal thesis(The impact of persistent poverty on rural urban migration in Nigeria)?

Explain regression model, In a study relating college grade point average t...

In a study relating college grade point average to time spent in various activities, students are asked how many hours they spend each week in four activities: studying, sleeping,

Level of interest rate, You have won a contest and are allowed to choose be...

You have won a contest and are allowed to choose between two prizes. One option is to receive $200 now and another $200 a year from now. The second option is $150 now and $255 a

Give me liberty, The textbook states, “Prejudice by itself did not create A...

The textbook states, “Prejudice by itself did not create American slavery.” Examine the forces and events that led to slavery in North America, and the role that racial prejudice p

Write Your Message!

Captcha
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