Cost of Capital, Capital
Structure, and Capital Budgeting Analysis
Purpose of the project
In this project, you are
supposed to be a financial manager working for a big corporation and you have
to apply the knowledge obtained from this course to determine the cost of debt,
cost of preferred stock, cost of common equity, capital structure, and the
weighted average cost of capital (WACC) for a publicly-traded company of your
choice. You will use the WACC as the discount rate to conduct capital budgeting
analysis for a project that the firm is considering and then decide whether it
should be accepted or not.
Outline for the project
1. Executive Summary
Summarize the results and
analysis of the report.
2. Estimate Capital Structure
Estimate the firm’s weights of
debt, preferred stock, and common stock using the firm’s balance sheet (book
value).
Estimate the firm’s weights of debt, preferred
stock, and common stock using the market value of each capital component.
3. Compute Weighted Average
Cost of Capital (WACC)
Estimate the firm’s before-tax and after-tax
component cost of debt;
Estimate the firm’s component cost of
preferred stock;
Use three approaches (CAPM,
DCF, bond-yield-plus-risk-premium) to estimate the component cost of common
equity of the firm.
Calculate the firm’s weighted average cost of
capital (WACC) using market-based capital weights or book value of debt.
4. Cash Flow Estimation &
Capital Budgeting Analysis
We assume that the company you
selected is considering a new project. The project has 6 years’ life. This
project requires initial investment of $180 million to construct building, and
purchase equipment, and $12 million for shipping & installation fee. The
fixed assets fall in the 5-year MACRS class. The salvage value of fixed assets
is $25 million. The number of units of the new product expected to be sold in
the first year is 870,000 and the expected annual growth rate is 10%. The sales
price is $250 per unit and the variable cost is $175 per unit in the first
year. The required net operating working capital (NOWC) is 18%. The company is
in the 33% tax bracket. The project is assumed to have the same risk as the
corporation, so you should use the WACC you obtained from prior steps as the
discount rate. The project is assumed to have the same risk as the corporation,
so you should use the WACC you obtained from prior steps as the discount rate.
Compute the depreciation basis
and annual depreciation of the new project. (Please refer to table 11 A-2 MACRS
allowances)
Estimate annual cash flows for
the 6 years.
Draw a time line of the cash flows.
For this section of the project, students
should follow and use the Cash Flow Estimation Excel Template File provided
under the “Example Files for Term Project” folder.
5. Capital Budgeting Analysis
Using the WACC you obtained from step (3) for
the publicly-traded company as discount rate, apply capital budgeting analysis
techniques (NPV, IRR, PI, and Payback Period) to analyze the new project.
Discuss whether the project should be taken
and summarize your report.
Other information regarding the project
You will inform the instructor of the company
you choose for approval. Students have to choose different companies. If
several students want to use the same company, the first student to inform the
instructor will have priority; the others will have to pick another company.
Please make sure to post your company selection under the “Term Project”
discussion thread.
Students should submit two files:
A Microsoft Word file which is the written
report of your analysis. Your project should be well-organized and typed in a
Word, document but you must attach the necessary Excel workbook with your
report. The style and organization part of the project account for 10 percent
of the grade.
An Excel file which is the outcome of your
analysis. Please note that you should show formulas in Excel for all
calculations.
Avoid firms that are losing money (airlines
and other distressed firms).
Try to choose a small firm that operates in an
industry that’s familiar to you. Try to avoid firms that operate in several
industries (conglomerates such as GE) or companies whose performance depends on
commodity prices (XOM, VLO, PD, ABX) so your analysis doesn’t become too
complex.
DO NOT USE THE COMPANIES BELOW
AAPL, CVS, COST, GOOG, HD, SBUX, TGT, WMT, WAG, OMX.
This project should be
well-organized and typed in a Word document but you must attach the necessary
Excel workbook with your report.
