(Answered)-iAccessories Inc. is considering a new project for manufacturing - (2025 Updated Original AI-Free Solution
Question
- iAccessories Inc. is considering a new project for manufacturing cases for the new
iPad. They expect production to last for three years, since at the end of that
period Apple is expected to introduce an iPad replacement with a completely
different design. The equipment required for the project will cost $1.5 million
today, and it will be depreciated straight-line to zero over three years. They expect
to sell the equipment after three years for $200,000.
Sales of the cases are expected to be $5 million in the first year, and to grow at
10% a year over the next two years. The project will also require an initial (time
zero) investment in working capital of $500,000, and subsequent year-end
working capital balances will equal 10% of the next year?s sales (and the working
capital can be recovered at the end of the project life). Operating expenses will
equal 50% of same-year sales.
The firm pays taxes at a rate of 40%, has an equity beta of 1.25, and maintains a
D/V ratio of 0.5 while borrowing at an annual yield of 7%. The risk-free rate is
currently 5%, and the expected return on the market is 13%. This project is
viewed as having a similar risk to the company overall.
(a) Calculate the free cash flows that should be used to value the
project.
(b) What is the appropriate discount rate to use for this new project?
(c) What is the NPV of the project? Should the company invest in
the project?
(d) If the company were to become unlevered, i.e., issue equity to
buy back all of its debt, what would the NPV of the project be in this case?
What accounts for the difference?
3. Gil Bates currently holds only two securities in his portfolio:
i) One million shares of Macrosoft. Macrosoft?s stock will pay no dividend this
coming year, but will start paying yearly dividends at the end of the following
year (two years from today). The dividend in two years? time will be $1 and then
will grow at an annual rate of 5% forever. Macrosoft?s equity beta is 1.2, the
annual risk-free rate is 4%, and the expected return on the market is 12%.
(Macrosoft stock plots on the Security Market Line, i.e., its expected rate of return
is based on the CAPM.)
ii) AAA-rated bonds of Amazing.com that collectively have a $10 Million face
value. The bonds have a five-year maturity, an 8% annual coupon rate with
coupons paid out semi-annually (the next one in six months), and a yield-tomaturity
of 5% (an APR assuming semi-annual compounding).
- What is the total value of Gil?s stock holdings in Macrosoft?
- What is the total value of Gil?s Amazing bond holdings?
4. Argyle Corp has the following securities outstanding:
1 Million shares of common stock. The shares are priced such that the firm?s
P/E multiple is 10, i.e., the price per share is 10 times the earnings per share.
1,000 perpetual bonds, each with a face value of $1,000, a coupon rate of 10%
(paid once a year) and a current yield (an effective annual rate) of 8%. These
bonds will pay annual interest every year for ever, and there will be no
principal paid back (or, if you like, this happens at infinity!).
The firm has EBIT every year, forever, of $500,000, and pays out all of its net
income as dividends. The tax rate is 30%.
- What is the current market value of the firm?s equity and debt?
- What is the required rate of return on the firm?s equity? What is
the beta of the equity?
- What is the firm?s (after-tax) WACC?
5. Terra Pins, a bowling pin manufacturer based in Maryland, is considering a
capital restructuring proposal. The firm currently has $100 Million in market value of
common stock outstanding, priced at $50 per share. It currently has no debt, but is
considering restructuring by issuing (at par value) $50 Million of debt that will pay an
8% annual coupon (once a year) forever. The proceeds from the debt will be used to
repurchase an equivalent amount of stock. Earnings before interest and taxes (EBIT)
for the firm is $10 Million every year, forever. Assume that there are no taxes and
that markets are otherwise perfect as originally assumed by Modigliani & Miller.
a) If there are no taxes, what will the effect of the proposed restructuring
be on Terra Pins? earnings per share (EPS)? Show explicitly the EPS before and
after the restructuring.
b) If there are no taxes, what will the effect of the proposed restructuring
be on Terra Pin?s required return on equity? Show explicitly the return on equity
before and after the restructuring.
c) If the firm pays taxes at a 34% tax rate, what would the value of the firm be
before and after the capital restructuring?
6. You have been asked by your new employer Doodle to value a social networking
company named INOU
as a potential acquisition target. INOU is currently trading for $50
per share, and there are 20 million shares outstanding. Current management of INOU is
only willing to accept an offer valued at $55 per share or higher. You are trying to
assess whether Doodle should pay this price, i.e., whether Doodle would create value
for its shareholders through an acquisition at this price.
You have the following information for INOU for their fiscal year 2011 which ended
December 31, 2011 (all numbers in millions):
Sales 1,000
COGS 800
Depreciation 50
Increase in Working Capital 5
Capital Expenditures 60
The free cash flow to the firm is expected to grow at 3% a year forever. Corporate
taxes paid are expected to be 35% of EBIT, which is the marginal tax rate. The beta
of INOU is 1.2. The risk-free rate is 3%, and the risk premium on the market is 7%.
INOU has $1 Billion of debt at a cost of debt of 5%.
(a) What is the forecasted free cash flow for INOU in 2012?