In looking to refurbish a former mill building, we have the following information:
Weights of 30% debt and 70% common equity (no preferred equity)
A 35% tax rate
The cost of debt is 9%
The beta of the company is 1.2
The risk free rate is 2%
The return on the market is 12%
Initial investment outlay of $60 million, comprised of $50 million for machinery with $10 million for net working capital (metal and gemstone inventory)
Project and equipment life is five years
Revenues are expected to increase $50 million annually
Gross margin percentage is 60% (not including depreciation)
Depreciation is computed at the straight line rate for tax purposes
Selling, general, and administrative expenses are 5% of sales
Tax rate is 30%, a reduced rate that reflects a tax credit due to the repurpose of the building
WACC = 11.56%
NPV = 29.61.
IRR = 26.88%.
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Question: Provide a 250–500 word executive summary on the results of the decision rule. Would you recommend that Felicia & Fred move forward with this project based on the NPV and IRR rules and outcomes? Why or why not? Consider any qualitative aspects of the decision as well. Provide a response with quantitative details which will be presented for consideration at the next executive board meeting.
Executive summary on the results of the decision rule
Figure of Capital Contribution and funding for proposed investment
outlay of $60 million
comprised of $50 million for machinery with $10 million for net working capital
net working capital (metal and gemstone inventory)
Project and equipment life is five years
Revenues are expected to increase $50 million annually
Gross margin percentage is 60%
Capital Budgeting Analysis
On Analysis of above proposal for refurbish a former mill building, we have found following
Weighted Average cost of capital is 11.56%
Net present value of the project is 29.61 %
IRR of the project is 26.88%
Impact of Capital Budgeting Analysis
As we can see that NPV of the project is Positive and when the present value of the expected cash outflows is greater than the present value of the expected cash inflows then IRR (Internal Rate of return ) is grater then WACC of the firm. So we can say that proposed investment gives more return to the company than actual WACC of the company So my suggestion is to go for the project.
