The Campbell Company is a manufacture.
Their capital structure comprises
1. Long-Term debt, with an incremental borrowing rate of 8%
2. Capital stock, with the following information:
Risk free rate 6%
Market rate of return 13%
Beta 1.2
Long-Term debt 40% of sum financing
Capital Stock 60% of sum financing
The company’s tax rate is 40%
Required:
Using CAMP, evaluate the cost of equity financing
Evaluate the Weighted Average Cost of Capital
Analyze the subsequent 4 independent projects:
Use NPV
IRR
Payback
To determine if the project must be accepted or rejected
IGNORE: Terminal cash flows and Working Capital needs. (Use 7 year depreciation table)
Use 7 year depreciation table (tax-depreciation)
Project 1
Purchase of capital equipment for expansion
Capital expenditure 1,000,000
Useful life 8 years
Pre-tax Cash flows (not including depreciation)
Year Revenues Costs
1 250,000 100,000
2 262,500 105,000
3 275,625 110,250
4 289,406 115,763
5 303,877 121,551
6 319,070 127,628
7 335,024 134,010
8 351,775 140,710
2,387,277 954,911
Project 2
Purchase of capital equipment for expansion
Capital expenditure 500,000
Useful life 8 years
Pre-tax Cash flows (not including depreciation)
Year Revenues Costs
1 250,000 100,000
2 262,500 105,000
3 275,625 110,250
4 289,406 115,763
5 303,877 121,551
6 319,070 127,628
7 335,024 134,010
8 351,775 140,710
2,387,277 954,911
Project 3
Purchase of capital equipment for replacement
Capital expenditure 1,000,000
Useful life 8 years
Pre-tax Cash flows (not including depreciation)
Year Revenues Costs
1 200,000 -
2 210,000 -
3 220,500 -
4 231,525 -
5 243,101 -
6 255,256 -
7 268,019 -
8 281,420 -
1,909,822 -
Project 4
Purchase of capital equipment for replacement
Capital expenditure 700,000
Useful life 8 years
Pre-tax Cash flows (not including depreciation)
Year Revenues Costs
1 - (200,000)
2 - (200,000)
3 - (200,000)
4 - (200,000)
5 - (200,000)
6 - (200,000)
7 - (200,000)
8 - (200,000)
- (1,600,000)
*Suppose 200,000 is positive cash flow