Contents

Title: Weighted Average Cost of Capital

Your business has a weighted average cost of capital (WACC) of 10% and you have sufficient cash from internal operations to consider investing in a project. The project presented to you requires an initial outlay of $200K and working capital of $50K (which will be returned at the end of the project because it is advance inventory that will be used). The project manager and you determine that over the next three years, which the life of the project is, that your company will realize an improvement in earnings before depreciation of $100K each year. The project manager feels that at the end of the project he can get $150K for various pieces of the project.

            Assume:

1. 50K depreciation a year
2. Tax rate of 40%
3. You sell the pieces for the 150K the first day of the fourth year.
4. Round to nearest k dollars

Question 1: What is the net cost of the project for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)

2. What are the net operating cash flows for years 1, 2, and 3?

3. What is the terminal Cash flow?

4. If you use the WACC rate of 10%, should you go ahead with the Project? Yes, No,

5. You decide after reviewing the information, discussing the project with others, and reviewing the planned versus actual outcome of prior projects—that you should account for various risks by using a discount rate which is higher than the WACC—you choose 14%. Would you still want to go ahead with the project? Yes, No

After thinking about the project some more time, you decide that for various reasons that you would be lucky to sell the pieces of the project at the end for 50K. Assuming you continued to use the 14% rate---

6. Would you still want to go ahead with the project? Yes__ No? Please explain your answer.

Number of words: 613 inclusive of the above questions