Your firms SVP of Finance asked you to evaluate an investment opportunity that the development team proposed.
Question:
Your firm’s SVP of Finance asked you to evaluate an investment opportunity that the development team proposed. Here are some pro-forma financial forecasts for the investment opportunity: (in $)
Year | 0 | 1 | 2 | 3 | 4 | 5 |
Sales revenue | 12,000.00 | 12,108.00 | 12,241.19 | 12,388.08 | 12,536.74 | |
Costs of goods sold | 5,000.00 | 5,045.00 | 5,100.50 | 5,161.71 | 5,223.65 | |
SG&A, incl. Depreciation | 2,250.00 | 2,270.25 | 2,295.22 | 2,322.76 | 2,350.63 | |
EBIT | 4,750.00 | 4,792.75 | 4,845.47 | 4,903.61 | 4,962.46 | |
Interest expense | 305.00 | 307.75 | 311.14 | 314.87 | 318.65 | |
Taxable income | 4,445.00 | 4,485.00 | 4,534.33 | 4,588.74 | 4,643.81 | |
Income tax expense (23%) | 1,022.35 | 1,031.55 | 1,042.90 | 1,055.41 | 1,068.08 | |
Net Income | 3,422.65 | 3,453.45 | 3,491.43 | 3,533.33 | 3,575.73 | |
Depreciation | 750.00 | 756.75 | 765.07 | 774.25 | 783.54 | |
Capital Expenditure | 23,600.00 | 1,300.00 | 1,311.70 | 1,326.13 | 1,342.04 | 1,358.14 |
Net Working Capital level | 7,900.00 | 8,075.00 | 8,147.68 | 8,237.30 | 8,336.15 | 8,436.18 |
These new operations would be very similar to your firm’s existing operations, in terms of growth, riskiness, and optimal capital structure. They are expected to produce cash flows indefinitely. UFCF growth of 1.1% is expected after year 5.
Some information about the firm's balance sheet and cost of capital:
Market value of long-term debt $1,300,000.00
Number of shares outstanding 520,000
Most recent share price $17.50
Return on debt 5.700%
Stock beta 1.446
Risk-free rate 2.700%
Market risk premium 6.100%
Income tax rate 23.0%
The SVP is thinking of raising the firm’s leverage ratio to 15% in the near future, so the new operations should (in anticipation of that change) start with (and then maintain) a leverage ratio of 15.0%. With that leverage, lenders would expect a return of 6.2%.
The SVP asked you to evaluate this project: Is it a good idea? Explain carefully, and provide all useful information the SVP may want to see. Use the WACC in your answer. Show your work.
College Accounting
ISBN: 978-1111528126
11th edition
Authors: Tracie Nobles, Cathy Scott, Douglas McQuaig, Patricia Bille