According to the CFO of Kansas City Southern (KSU), the railroad spent $175 million by to rebuild 83 miles of an abandoned rail line previously owned by Union Pacific to provide the railroad with ready access to growing markets in Mexico. The railroad predicts a free cash flow of $24 million per year from the project. From the standpoint of net present value, do you think this is a good investment? To begin, the company’s WACC was 8.71% from 2009 through 2017. You will need its WACC for 2018, 2019, and 2020. To guide your analysis, please see the railroad’s Value Line summary page on Blackboard under “KSU 2020,” which includes KSU’s (financial) capital structure and estimated beta. The company’s bond rating is “BBB,” as assessed by the Standard & Poor’s Corporation, with an interest rate of 4.4%. For ease of estimation, assume a corporate tax rate of 21%. Please show all your work. (Hint: To estimate the WACC, you will need the cost of equity from the estimates of the capital asset pricing model in problem 7. Because the KSU data are annual but the CAPM data are monthly, you will have to annualize the CAPM estimates before estimating KSU’s cost of equity.)

b. (5 points) In what year does the internal rate of return exceed the WACC? What do you conclude by comparing the internal rate of return to a less formal means of estimating the cost of capital, such as the current interest rate on the bonds plus three percentage points? What do you conclude about the profitability of the project now? Please show your work.

Problem 7 data

Symbol	E(Ri)	Beta
AA	0.8	1.3
AXP	0.8	1
BA	1	0.8
C	0.8	1.35
CAT	1.2	1.7
CSCO	0.6	0.95
KO	0.4	0.6
DIS	0.6	0.95
DD	0.6	0.7
ED	0.4	0.55
XOM	0.4	0.6
GE	0.5	0.9
GM	0.6	0.8
HPQ	0.4	1.3
HD	0.4	0.9
HON	0.9	1.15
INTC	0.8	1.1
IBM	0.9	1.4
IP	0.4	0.8
JNJ	0.3	0.35
MCD	0.6	0.5
MSFT	0.8	1.2
MMM	0.5	0.9
JPM	1	1.3
PG	0.4	0.45
D	0.6	0.5
T	0.6	1
UTX	1.1	1.1
WMT	1	0.8
WFC	0.7	1.2

Answer rating: 100% (QA)

To calculate the WACC for 2018 2019 and 2020 Step 1 Calculate the cost of equity Using the CAPM data ... View the full answer