Answer the Requirements
Question Description
1. What are the initial sales (year 1)?
2. Whatis the annual sales growth (years 2 to 5)?
3. Whatare the operating expenses (as a % of sales) and what are the fixed costs?
4. Whatis the upfront investment in net fixed assets (i.e., the initial capitalspending) you need to make today (year 0)? Depreciate the value of these assetson a straight-line basis to zero over the five-year horizon.
5. Whatis the salvage value of these assets at the end? (has to be a positive number)
6. Whatis your upfront investment in net working capital (year 0)?
7.Starting in year 1, net working capital (the liquidity you need) will be basedon how much are your sales. How much (as a % of sales) do you need to retain inNWC every year? (for example, you can assume that you need NWC equal to 10% ofsales each year after year 0 and then figure out the change in NWC each year).The last year you assume that you recover all the dollar amount invested duringthis period in NWC.
8.Assume that the corporate income tax rate is 21%.
Cost ofCapital (WACC)
To find your weighted average cost of capital (WACC) you’ll needto find certain key inputs for your company.
I. How much of your total assets will be financed with debt andhow much by equity (i.e., your own capital)? Use this information to determinethe equity weight (i.e., E/A) and debt weight (i.e., D/A). In other words, youshould choose your “target” debt-equity mix. If you are not sure what this mixshould be, find the (Total) Debt/Equity ratio or the “debt ratio” (Total) Debt/Assets for the industry (both numbers should be based on market values).Otherwise let us know what you chose and why.
II. What is the cost of debt for your company? Assume that thecost of debt for your company is: The 3-month Treasury Bill rate + 7%. In thecurrent economic environment, the T-Bill rate is unusually low, so we want youto use 3%. (NOTE: In future classroom or business situations, when thingssettle down in the economy, you can find the 3-month T-Bill rate from the SaintLouis Fed’s FRED https://fred.stlouisfed.org/.) The 7% premium is to accountfor your company’s default risk. So, your company’s cost of debt is 10%.
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