The Pizza Company is considering a new three-year expansion project. The key data are shown below:
• The company hired a consulting firm to help evaluate the project and paid the
consulting fee of $60,000.
• The company owns the space. If company did not invest in the project, it can receive after-tax rental fee for $300,000 per year for 3 years. However, if the company invested in the project, it will use the space for the project.
• The fixed cost to produce pizza is required at $150,000 per year.
• It is estimated that 50,000 units will be sold in the first year and that 40,000 units and 30,000 units will be sold in the second and third years respectively.
• Each pizza is expected to sell for $25 and the production cost will be $15 per unit.
• The sales price and variable cost should increase with inflation. Expected inflation rate per year is 5%.
• The project requires an initial investment in working capital of $500,000, which will be required in each year at 10% of revenue in the following year.
• The purchase of the machinery at the start of the project is $1,000,000. The shipping and installation cost are $200,000. The machinery will be depreciated straight-line to zero. It is estimated that the machinery can be sold at the end of the project for $250,000.
• To finance the project, the company would need to take a one-million dollar loan at 8% interest rate p.a. from HSBC over the life of the project. Annual interest expense is $80,000.
• The corporate tax rate is 34%.
• The Pizza Company is evaluating its cost of capital under alternative financing arrangements. In consultation with the consulting firm, the Pizza Company expects to be able to issue new Debt at Par with a coupon rate of 8% (coupons paid annually) and to issue new preferred stock with a $4 per share dividend at $32 a share. The common stock of the Pizza Company is currently selling for $22 a share while its book value is $6. The Pizza Company expects to pay a total dividend of $525,000 for its 200,000 common shares outstanding next year. Market analysts foresee a growth in dividends of the company at the rate of 4% per year. The Pizza Company raises capital using 30% bond, 20% preferred stock, and 50% common stock.
a. What is the cost of capital (WACC) of the Pizza Company?
b. Calculate the NPV of the project using the cost of capital calculated in part (a).
Should the project be accepted?
The Pizza Company is considering a new three-year expansion project. The key data are shown below:
• The company hired a consulting firm to help evaluate the project and paid the
consulting fee of $60,000.
• The company owns the space. If company did not invest in the project, it can receive after-tax rental fee for $300,000 per year for 3 years. However, if the company invested in the project, it will use the space for the project.
• The fixed cost to produce pizza is required at $150,000 per year.
• It is estimated that 50,000 units will be sold in the first year and that 40,000 units and 30,000 units will be sold in the second and third years respectively.
• Each pizza is expected to sell for $25 and the production cost will be $15 per unit.
• The sales price and variable cost should increase with inflation. Expected inflation rate per year is 5%.
• The project requires an initial investment in working capital of $500,000, which will be required in each year at 10% of revenue in the following year.
• The purchase of the machinery at the start of the project is $1,000,000. The shipping and installation cost are $200,000. The machinery will be depreciated straight-line to zero. It is estimated that the machinery can be sold at the end of the project for $250,000.
• To finance the project, the company would need to take a one-million dollar loan at 8% interest rate p.a. from HSBC over the life of the project. Annual interest expense is $80,000.
• The corporate tax rate is 34%.
• The Pizza Company is evaluating its cost of capital under alternative financing arrangements. In consultation with the consulting firm, the Pizza Company expects to be able to issue new Debt at Par with a coupon rate of 8% (coupons paid annually) and to issue new preferred stock with a $4 per share dividend at $32 a share. The common stock of the Pizza Company is currently selling for $22 a share while its book value is $6. The Pizza Company expects to pay a total dividend of $525,000 for its 200,000 common shares outstanding next year. Market analysts foresee a growth in dividends of the company at the rate of 4% per year. The Pizza Company raises capital using 30% bond, 20% preferred stock, and 50% common stock.
a. What is the cost of capital (WACC) of the Pizza Company?
b. Calculate the NPV of the project using the cost of capital calculated in part (a).
Should the project be accepted?
