As a recent graduate of the UWIOC, The General Manager of the company has hired you to work alongside the Financial Controller of the company to help determine whether the company should invest in the new product line. He has provided you with the following questions to guide you in your assessment of the project and to present your findings to the Company. 1. Determine the weighted average cost of capital (WACC) for Vigour Pharmaceuticals. (Formula to be used is attached) The Weighted Average Cost of Capital (WACC)QThe WACC is found by weighting the cost of each specific type of capital by its proportion inthe firm's capital structure to find the average cost of funds over the long run. To determine theweights to use, simply add the total dollar amount of long-term financed capital and divideeach component by the total amount to find it proportion.Ta = (W₁ x ri) + (Wp X rp) + (Ws X rn)Where:w.= proportion of long-term debt in capital structurew,= proportion of preferred stock in capital structurew.= proportion of common stock in capital structureNote that wi+wp + ws = 1.0 newVigour Pharmaceuticals Ltd. is considering investing in aproduction line for its pain-reliever medicine for individuals whosuffer from cardio vascular diseases. The company has to invest inequipment which costs $2,500,000 and will be depreciated under theMACRS system for a 5-year asset class. It is expected to have a scrapvalue of $700,000 at the end of the project. Other than the equipment,the company needs to increase its cash and cash equivalents by$100,000, increase the level of inventory by $30,000, increaseaccounts receivable by $250,000 and increase account payable by$50,000 at the beginning of the project. Vigour Pharmaceuticals expectthe project to have a life of five years. The company would have topay for transportation and installation of the equipment which has aninvoice price of $450,000.The company has already invested $75,000 in Research and Developmentand therefore expects a positive impact on the demand for the newpain-reliever. Expected annual sales for the product in the firstthree years are $600,000 and $850,000 in the following two years. Thevariable costs of production are projected to be $267,000 per year inyears one to three and $375,000 in years four and five. Fixed overheadis $180,000 per year over the life of the project.The introduction of the new line of pain reliever will cause a netdecrease of $50,000 in profit contribution due to a decrease in salesof the other lines of pain relievers produced by the company. Byinvesting in the new product line Vigour Pharmaceuticals would haveto use a packaging machine which the company already has. It is fullydepreciated and could be sold at the end of the project for $350,000after-tax in the equipment market.The company's financial analyst has advised Vigour Pharmaceuticals touse the weighted average cost of capital as the appropriate discountrate to evaluate the project. The following information about thecompany's sources of financing is provided below:a. The company will contract a new loan in the sum of $2,000,000that is secured by machinery and the loan has an interest rateof 6 percent.1.b. Vigour Pharmaceuticals has also issued 4,000 new bond issueswith an 8 percent coupon, paid semi-annually and matures in 10years. The bonds were sold at par, and incurred floatation costof 2 percent per issue.c. The company's preferred stock pays an annual dividend of 4.5percent and is currently selling for $60, and there are 100,000shares outstanding.d. There are 300,000 million (Delete 'million') shares of commonstock outstanding, and they are currently selling for $21 each.The beta on these shares is 0.95.Other relevant information is as follows:The 20-year Treasury Bond rate is currently 4.5 percent and youhave estimated market-risk premium to be 6.75 percent using thereturns on stocks and Treasury bonds.ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. Inthe event of a negative taxable income, the tax is computed asusual and is reported as a negative number, indicating areduction in loss after tax.

WACC: It represents the company's average cost of capital and is estimated by taking the sum of all…

Answered: As a recent graduate of the UWIOC, The…

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS