Q1:
COMPUTE WEIGHTED AVERAGE COST OF CAPITAL |
enter data in blue-colored cells |
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BASIC: |
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Formula |
Equation |
COST OF DEBT: |
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Coupon Rate |
0.00% |
given |
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Marginal Tax Rate |
0.0% |
given |
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Cost of Debt |
0.00% |
b5*(1-b6) |
k-d = I x (1-t) |
weight of debt |
0% |
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d ÷ d+e |
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COST OF EQUITY: |
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Risk-Free Rate |
0.00% |
given |
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Risk Premium |
0.00% |
given |
R-m - R-f |
Beta |
0.00 |
given |
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Cost of Equity |
0.00% |
b11+(b13*b12) |
k-e = R-f + [ß x (R-m - R-f)] |
weight of equity |
100% |
1-b8 |
e ÷ d+e |
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Weighted-Average Cost of Capital |
0.00% |
(b8*b7)+(b15*b14) |
(k-d x wt-d)+(k-e x wt-e) |
Page 75 in Cohen Finance Workbook displays a K-wacc calculation for a company.
Suppose that the inputs to that k-wacc calculation have changed.
The company's financial risk has increased, so its coupon rate is now 9%.
Its marginal tax rate increased to 30%.
To reduce financial risk, its 'target' weight of debt is reduced to 30%.
The risk-free rate on treasury bonds is now 2%.
The risk premium stays the same at 8%.
The beta, reflecting higher financial risk, rises to 1.5.
Recalculate k-wacc, using the template at the top of this page.
Explain the significance of the change in k-wacc to the capital budgeting analysis and recommendation. Use the box below:
Q2a - Explain how the table below works, i.e., what are the inputs, what are the outputs, and how are the inputs transformed into the outputs.
HINT: Examine the formulas in the cells.
Change in Net Working Capital: |
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Revenue |
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1000.0 |
1000.0 |
1000.0 |
1000.0 |
1000.0 |
Cost of goods sold |
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22.0 |
22.0 |
22.0 |
22.0 |
22.0 |
Receivables (enter days in Column B) |
30 |
82.2 |
82.2 |
82.2 |
82.2 |
82.2 |
Inventory (enter days in Column B) |
50 |
3.0 |
3.0 |
3.0 |
3.0 |
3.0 |
Payables (enter days in Column B) |
25 |
1.5 |
1.5 |
1.5 |
1.5 |
1.5 |
Net working capital needs |
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83.7 |
83.7 |
83.7 |
83.7 |
83.7 |
Liquidation of working capital |
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0.0 |
Investment in working capital |
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83.7 |
0.0 |
0.0 |
0.0 |
0.0 |
Q2b - Row 43 changes compared to row 14 in Q2a. Explain how the investment in working capital changes (compared to the amount in Q2a) and why. Change in Net Working Capital:
Revenue |
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1000.0 |
1100.0 |
1200.0 |
1300.0 |
1400.0 |
Cost of goods sold |
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22.0 |
24.2 |
26.4 |
28.6 |
30.8 |
Receivables (enter days in Column B) |
30 |
82.2 |
90.4 |
98.6 |
106.8 |
115.1 |
Inventory (enter days in Column B) |
50 |
3.0 |
3.3 |
3.6 |
3.9 |
4.2 |
Payables (enter days in Column B) |
25 |
1.5 |
1.7 |
1.8 |
2.0 |
2.1 |
Net working capital needs |
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83.7 |
92.1 |
100.4 |
108.8 |
117.2 |
Liquidation of working capital |
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0.0 |
Investment in working capital |
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83.7 |
8.4 |
8.4 |
8.4 |
8.4 |
Q2c - B71 and B72 are changed from the number of days in Q2a and Q2b. Explain how the investment in working capital changes (compared to the amount in Q2b) and why.
Change in Net Working Capital: |
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Revenue |
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1000.0 |
1100.0 |
1200.0 |
1300.0 |
1400.0 |
Cost of goods sold |
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22.0 |
24.2 |
26.4 |
28.6 |
30.8 |
Receivables (enter days in Column B) |
60 |
164.4 |
180.8 |
197.3 |
213.7 |
230.1 |
Inventory (enter days in Column B) |
100 |
6.0 |
6.6 |
7.2 |
7.8 |
8.4 |
Payables (enter days in Column B) |
25 |
1.5 |
1.7 |
1.8 |
2.0 |
2.1 |
Net working capital needs |
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168.9 |
185.8 |
202.7 |
219.6 |
236.5 |
Liquidation of working capital |
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0.0 |
Investment in working capital |
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168.9 |
16.9 |
16.9 |
16.9 |
16.9 |
Q3a
Free cash flow: |
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Operating cash flow |
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72.6 |
88.8 |
105.1 |
109.6 |
124.3 |
Minus: Invesment in net working capital |
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12.3 |
3.1 |
3.1 |
0.9 |
1.8 |
Minus: Investment in PPE (CapEx) |
300.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Plus: Salvage value |
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0.0 |
Free cash flow |
-300.0 |
60.3 |
85.7 |
102.0 |
108.7 |
122.5 |
Cumulative free cash flow |
-300.0 |
-239.7 |
-154.0 |
-52.0 |
56.7 |
179.2 |
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Discount rate (K-wacc) |
10.9% |
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Net Present Value (NPV) |
43.7 |
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Profitability Index (PI) |
1.1 |
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Internal Rate of Return (IRR) |
15.9% |
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Payback Period (PP) |
inspection |
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Using the data below for the three projects, and the formulas you discerned in B12, B13, and B14, calculate NPV, PI, and IRR for the three projects, using two different k-wacc discount rates, 8% and 11%. The data for Projects A,B,C are arrayed vertically; they are the same as row 8 in the horizontal panel above.
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Project A |
Project B |
Project C |
Initial Outlay |
-50,000 |
-100,000 |
-450,000 |
Cash Inflows: Yr 1 |
10,000 |
25,000 |
200,000 |
Yr 2 |
15,000 |
25,000 |
200,000 |
Yr 3 |
20,000 |
25,000 |
200,000 |
Yr 4 |
25,000 |
25,000 |
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Yr 5 |
30,000 |
25,000 |
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Q3b Interpret the meaning of the calculations you made in Q3a.
Hint: Do you recommend accepting or rejecting the projects?
Hint: What is the impact on the decision metrics when k-wacc changes from 8% to 11%?
Hint: Do all three decision metrics lead to the same recommendation?