Max Laboratories Inc. has been operating for over thirty years producing medications and food for pets...
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Max Laboratories Inc. has been operating for over thirty years producing medications and food for pets and farm animals. Due to new growth opportunities they are interested in your expert opinion on a series of issues described below. The firm has a target capital structure of 40 percent debt and 60 percent common equity, which the CFO considers to be the optimal capital structure and plans to maintain it in the future. Next year the firm forecasts Earnings per share (EPS) of $15. Max Labs has One million common shares outstanding. Note: In other words, the firm's Net Income equals $15,000,000 since $15 1,000,000 shares = $15 Million in Net Income. The firm has a line of credit at the local bank at the following interest rates: Can borrow up to $6,000,000 at an 8% interest rate; the rate goes to 10% for amounts above $6,000,000. The firm's interest subsidy tax rate is 25 percent. The firm plans to retain 70% of the forecasted Net income; the remaining 30% of the estimated profits will be paid as dividends to common shareholders next year. Note: This means that out of the $15,000,000 in Net income, $10.5 million go to Retained Earnings (515 million X 70%) and the Declared Dividends will be = 54.50 million ($15 million X 30%) Currently common shares sell for $110 and the expected earnings growth is 99%. The floatation costs to raise new common equity capital, equal 7% of the share price. 1. Estimate the weighted average costs of capital for Max Laboratories: A) After-tax cost of debt. B) Cost of equity. c) Cost of new equity. 2. Calculate the two Marginal cost of capital break points. Show the amount of total capital and how much would be raised from Common Equity and Debt at each point. A) Break point when the firm needs to borrow at the higher cost of debt but still does not need to issue new equity B) Break point when the firm needs to start issuing new equity (has exhausted the retained earnings). Notice that at this point the firm is already using the higher cost of debt. 3. Calculate the weighted average cost of capital at all the break points found on Question 2 above. Show the three amounts of capital that trigger each WACC A) Before the firm has to issue new debt B) with the highest cost of debt but before the firm has to issue new equity. c) with New cost of equity and at the most expensive cost of debt. SECTION 2 Max Laboratories is evaluating three independent projects Project 1: Dog Treats, Project 2: Dog Food, and Project 3: Dog Toys Use the firm's WACC calculated above to evaluate the projects. Initial Investment 1 2 3 4 Std. Deviation of IRR S S $ $ $ Treats 4,000,000 $ 1,200,000 $ 1,400,000 $ 1,500,000 $ 1,800,000 $ 10% Food Cash Flows 3,800,000 $ 800,000 $ 1,000,000 S 1,700,000 S 2,200,000 $ 896 Toys 4,400,000 2,300,000 1,900,000 1,000,000 800,000 1296 1. Calculate Payback Period, NPV, IRR, and MIRR for all projects. which project(s) should the firm accept? Explain in detail the reasons for your recomendation. For example, if you get a positive/negative NPV, is that a good or bad influence on your decision to approve/reject the project being evaluated? Also what is the criteria for IRR and MIRR? Max Laboratories Inc. has been operating for over thirty years producing medications and food for pets and farm animals. Due to new growth opportunities they are interested in your expert opinion on a series of issues described below. The firm has a target capital structure of 40 percent debt and 60 percent common equity, which the CFO considers to be the optimal capital structure and plans to maintain it in the future. Next year the firm forecasts Earnings per share (EPS) of $15. Max Labs has One million common shares outstanding. Note: In other words, the firm's Net Income equals $15,000,000 since $15 1,000,000 shares = $15 Million in Net Income. The firm has a line of credit at the local bank at the following interest rates: Can borrow up to $6,000,000 at an 8% interest rate; the rate goes to 10% for amounts above $6,000,000. The firm's interest subsidy tax rate is 25 percent. The firm plans to retain 70% of the forecasted Net income; the remaining 30% of the estimated profits will be paid as dividends to common shareholders next year. Note: This means that out of the $15,000,000 in Net income, $10.5 million go to Retained Earnings (515 million X 70%) and the Declared Dividends will be = 54.50 million ($15 million X 30%) Currently common shares sell for $110 and the expected earnings growth is 99%. The floatation costs to raise new common equity capital, equal 7% of the share price. 1. Estimate the weighted average costs of capital for Max Laboratories: A) After-tax cost of debt. B) Cost of equity. c) Cost of new equity. 2. Calculate the two Marginal cost of capital break points. Show the amount of total capital and how much would be raised from Common Equity and Debt at each point. A) Break point when the firm needs to borrow at the higher cost of debt but still does not need to issue new equity B) Break point when the firm needs to start issuing new equity (has exhausted the retained earnings). Notice that at this point the firm is already using the higher cost of debt. 3. Calculate the weighted average cost of capital at all the break points found on Question 2 above. Show the three amounts of capital that trigger each WACC A) Before the firm has to issue new debt B) with the highest cost of debt but before the firm has to issue new equity. c) with New cost of equity and at the most expensive cost of debt. SECTION 2 Max Laboratories is evaluating three independent projects Project 1: Dog Treats, Project 2: Dog Food, and Project 3: Dog Toys Use the firm's WACC calculated above to evaluate the projects. Initial Investment 1 2 3 4 Std. Deviation of IRR S S $ $ $ Treats 4,000,000 $ 1,200,000 $ 1,400,000 $ 1,500,000 $ 1,800,000 $ 10% Food Cash Flows 3,800,000 $ 800,000 $ 1,000,000 S 1,700,000 S 2,200,000 $ 896 Toys 4,400,000 2,300,000 1,900,000 1,000,000 800,000 1296 1. Calculate Payback Period, NPV, IRR, and MIRR for all projects. which project(s) should the firm accept? Explain in detail the reasons for your recomendation. For example, if you get a positive/negative NPV, is that a good or bad influence on your decision to approve/reject the project being evaluated? Also what is the criteria for IRR and MIRR?
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Answer rating: 100% (QA)
1 Estimate the weighted average costs of capital for Max Laboratories A Aftertax cost of debt Interest expense on debt 6000000 x 8 480000 Interest exp... View the full answer
Related Book For
Intermediate Accounting Volume 1
ISBN: 9781260306743
7th Edition
Authors: Thomas H. Beechy, Joan E. Conrod, Elizabeth Farrell, Ingrid McLeod Dick
Posted Date:
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