The introduction of the new line of pain reliever will cause a net decrease of $50,000 in profit contribution due to a decrease in sales of the other lines of pain relievers produced by the company. By investing in the new product line Vigour Pharmaceuticals would have to use a packaging machine which the company already has. It is fully depreciated and could be sold at the end of the project for $350,000 after-tax in the equipment market. The company’s financial analyst has advised Vigour Pharmaceuticals to use the weighted average cost of capital as the appropriate discount rate to evaluate the project. The following information about the company’s sources of financing is provided below: a. The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. b. Vigour Pharmaceuticals has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue. c. The company’s preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding. d. There are 300,000 million (Delete ‘million’) shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95. Other relevant information is as follows: i. The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds. ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax. 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. Determine the weighted average cost of capital (WACC) for Vigour Pharmaceuticals. 2. Calculate the initial cash flow of the project. 3. Calculate the operating cash-flows for all years of the project 4. Calculate the terminal cash flow of the project 5. Taking into consideration all the information given, determine the Net Present Value of the project and advice the company on whether to invest in the new line of product. 6. Why should the cost of capital used in capital budgeting be calculated as a weighted average of the capital component rather than the cost of the specific financing used to fund a particular project?
The introduction of the new line of pain reliever will cause a net decrease of $50,000 in profit contribution due to a decrease in sales of the other lines of pain relievers produced by the company. By investing in the new product line Vigour Pharmaceuticals would have to use a packaging machine which the company already has. It is fully depreciated and could be sold at the end of the project for $350,000 after-tax in the equipment market. The company’s financial analyst has advised Vigour Pharmaceuticals to use the weighted average cost of capital as the appropriate discount rate to evaluate the project. The following information about the company’s sources of financing is provided below: a. The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. b. Vigour Pharmaceuticals has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue. c. The company’s preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding. d. There are 300,000 million (Delete ‘million’) shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95. Other relevant information is as follows: i. The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds. ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax. 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. Determine the weighted average cost of capital (WACC) for Vigour Pharmaceuticals. 2. Calculate the initial cash flow of the project. 3. Calculate the operating cash-flows for all years of the project 4. Calculate the terminal cash flow of the project 5. Taking into consideration all the information given, determine the Net Present Value of the project and advice the company on whether to invest in the new line of product. 6. Why should the cost of capital used in capital budgeting be calculated as a weighted average of the capital component rather than the cost of the specific financing used to fund a particular project?
Essentials Of Investments
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
Related questions
Question
The introduction of the new line of pain reliever will cause a net
decrease of $50,000 in profit contribution due to a decrease in sales
of the other lines of pain relievers produced by the company. By
investing in the new product line Vigour Pharmaceuticals would have
to use a packaging machine which the company already has. It is fully
depreciated and could be sold at the end of the project for $350,000
after-tax in the equipment market.
The company’s financial analyst has advised Vigour Pharmaceuticals to
use the weighted average cost of capital as the appropriate discount rate to evaluate the project. The following information about the
company’s sources of financing is provided below:
a. The company will contract a new loan in the sum of $2,000,000
that is secured by machinery and the loan has an interest rate
of 6 percent.
b. Vigour Pharmaceuticals has also issued 4,000 new bond issues
with an 8 percent coupon, paid semi-annually and matures in 10
years. The bonds were sold at par, and incurred floatation cost
of 2 percent per issue.
c. The company’s preferred stock pays an annual dividend of 4.5
percent and is currently selling for $60, and there are 100,000
shares outstanding.
d. There are 300,000 million (Delete ‘million’) shares of common
stock outstanding, and they are currently selling for $21 each.
The beta on these shares is 0.95.
Other relevant information is as follows:
i. The 20-year Treasury Bond rate is currently 4.5 percent and you
have estimated market-risk premium to be 6.75 percent using the
returns on stocks and Treasury bonds.
ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In
the event of a negative taxable income, the tax is computed as
usual and is reported as a negative number, indicating a
reduction in loss after tax. 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.
Determine the weighted average cost of capital (WACC) for Vigour
Pharmaceuticals.
2. Calculate the initial cash flow of the project.
3. Calculate the operating cash-flows for all years of the project
4. Calculate the terminal cash flow of the project
5. Taking into consideration all the information given, determine
the Net Present Value of the project and advice the company on
whether to invest in the new line of product.
6. Why should the cost of capital used in capital budgeting be
calculated as a weighted average of the capital component rather
than the cost of the specific financing used to fund a particular
project?
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