Calculate the weighted average cost of capital (WACC) using the market value of equity to determine a more realistic cost of capital. Visit a Web site to get the current value of the common stock price per share and multiply this value times the most recent number of shares of common stock outstanding. In this exercise, you will be ignoring preferred stock because its weight value will most likely be too low to impact the final result. You may use the following table to complete this portion of the task:
|Company||Common Stock, price per share||Number of Common Shares Outstanding||Market Value of Common Equity|
Now, you can estimate the total market value of the company by adding the book value of total liabilities to the market value of the firm’s common equity and determine their market value weights.
|Company||Total Liabilities||Market Value of Common Equity||Market Value of the Firm|
Using the cost of each component as determined in the Phase 4 IP, calculate the firm's market value WACC.
|After-Tax Cost of Debt||Cost of Common Equity||WACC|
|Market Weight of Component|
|Market Weighted Cost of Component|
The firm is considering investing in a capital project that will have an initial cost of $12 million. The project is expected to have a productive life of 5 years, and at the end of this period, it is expected to have a salvage value of $2 million. The net value of the project will be depreciated using the straight-line method for the full 5 years. The project is expected to increase the firm’s revenue by $10 million per year, and related expenses (not including depreciation) are expected to increase by about $6.5 million per year.
The first thing you need to do is calculate the annual depreciation. Feel free to use the following table:
|less Salvage Value|
|Life of Project (years)|
Now, you need to calculate the relevant cash flows for the project. You can use the average tax rate that was calculated in Phase 4 to determine the additional taxes the firm will have to pay. The following template may be of some assistance to you:
|Initial Investment (negative)|
|Increase in Revenue|
|Less Increase in Operating Expenses|
|Increase in Operating Income|
|Less Taxes at Average Rate|
|Operating Cash Flow|
|Plus Salvage Value (Year 5)|
|Relevant Cash Flows (0–5)|
At this point, you are ready to apply the capital budgeting techniques of net present value (NPV) and the internal rate of return (IRR). To calculate the NPV, use the market-value WACC as your discount rate and the required rate of return for IRR.
Why is operating cash flow used in capital budgeting and not net income?
Length: 3 pages (902 Words)
Determination of the market value of the firm
The analysis was based on Tesco Plc. a supermarket chain whose home market is in the United Kingdom. The share price as per the end of the year 2014 on which the study is based is £230. The amount of shares outstanding as at December 2014 are 80,680,000. The market value as of the same date is determined to be £8,556,400,000.
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