Our ultimate goal is to advise Bob, the owner of Gerard's Bike Shop, whether he should invest in new, high-tech, tungsten inert gas (TIG) frame welding machinery for his mountain bike building business. To do so properly, you must:

1) Estimate the expected CAPM cost of Equity from market data. 

2) Estimate the cost of Debt from market prices and the current level of interest rates. 

3) Calculate the WACC 

4) Use the WACC to calculate the NIV of the TIG welder project. SHOW ALL OF YOUR WORK AND CARRY ALL CALCULATIONS TO 4 DECIMAL PLACES.

EYE 2009 Market Value Capital Summary

Long-term Debt: 21,000,000

Shareholder's Equity: 80,000,000

Total Capital: 101,000,000

Assume today is 1/1/2010. The long-term debt consists of 20,000 bonds, each of which has a par value of $1,000, carries an annual coupon of $88, and matures in 10 years. The current price on each bond is $1050. The current U.S. Treasury long-bond carries a 5.35% rate of interest.

The firm's 2,000,000 shares of common stock outstanding currently sell for $40 per share, creating a market capitalization of $80 million. Overall, investors have enjoyed a 13.8% return in the U.S. stock market in recent years and this is expected to continue. ValueLink assigns a Beta of 1.30 to Gerard's Bike Shop. Bob's marginal state-plus-federal tax rate is 38%.

The new TIG welding machinery will cost $1,375,000, including shipping and installation, and the cost will be recovered using the MACRS 3-year convention of 33%,45%,15% & 7%. Bob estimates the new technology will allow initial sale of 2,500 bikes, with volume increasing by 6% p.a. over 2010-2013. Bob wants to keep the wholesale price per bike at $550to achieve market share. Initial annual fixed costs at $275,000 p.a. will remain fixed over the period while variable costs will start at $200 per unit and increase by 5% p.a. An initial net working capital investment of $40,000 will also be required. Gerard expects that the machinery will have a salvage value of $50,000.

Help Bob out Calculate the NPV and IRR of the TIG capital project (using the WACC as the discount rate) and give him your advice on the purchase.

Transcribed Image Text:

BUDA EASY WACC & DETAILED CAPEX Long-Term Debt (8.80% coupon) Due 2019 Shareholder's Equity Total Market Value Capital Cost of Debt (RD) @ Market Long-Term Risk-Free Rate (RRF) Beta: ValuLink LT-Debt Market Yield: WACC= Component L-T Debt Common Stk. # of Bonds Outstanding Bob's Common Stock (NASDAQ: BUDA) U. S. Equities (RM): Page 2 of 3 Tax Rate: CAPM Rs = Market Values WACC Data: Risk Free + After-Tax Price % of Total Weighting # Shares (MR Prem. Weight x Beta) Product = WACC BUDA EASY WACC & DETAILED CAPEX Long-Term Debt (8.80% coupon) Due 2019 Shareholder's Equity Total Market Value Capital Cost of Debt (RD) @ Market Long-Term Risk-Free Rate (RRF) Beta: ValuLink LT-Debt Market Yield: WACC= Component L-T Debt Common Stk. # of Bonds Outstanding Bob's Common Stock (NASDAQ: BUDA) U. S. Equities (RM): Page 2 of 3 Tax Rate: CAPM Rs = Market Values WACC Data: Risk Free + After-Tax Price % of Total Weighting # Shares (MR Prem. Weight x Beta) Product = WACC

Answer rating: 100% (QA)

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