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Assignment 1: LASA # 2—Capital Budgeting Techniques

As a financial consultant, you have contracted with Wheel Industries to evaluate their procedures involving the evaluation of long term investment opportunities. You have agreed to provide a detailed report illustrating the use of several techniques for evaluating capital projects including the weighted average cost of capital to the firm, the anticipated cash flows for the projects, and the methods used for project selection. In addition, you have been asked to evaluate two projects, incorporating risk into the calculations.

You have also agreed to provide an 8-10 page report, in good form, with detailed explanation of your methodology, findings, and recommendations.

Company Information

Wheel Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35%.

Required:

Wheel has just paid a dividend of $2.50 per share. The dividends are expected to grow at a constant rate of six percent per year forever. If the stock is currently selling for $50 per share with a 10% flotation cost, what is the cost of new equity for the firm? What are the advantages and disadvantages of using this type of financing for the firm?

The firm is considering using debt in its capital structure. If the market rate of 5% is appropriate for debt of this kind, what is the after tax cost of debt for the company? What are the advantages and disadvantages of using this type of financing for the firm?

The firm has decided on a capital structure consisting of 30% debt and 70% new common stock. Calculate the WACC and explain how it is used in the capital budgeting process.

Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.

If the discount rate were 6 percent calculate the NPV of the project. Is this an economically acceptable project to undertake? Why or why not?

Now calculate the IRR for the project. Is this an acceptable project? Why or why not? Is there a conflict between your answer to part C? Explain why or why not?

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Wheel has two other possible investment opportunities, which are mutually exclusive, and independent of Investment A above. Both investments will cost $120,000 and have a life of 6 years. The after tax cash flows are expected to be the same over the six year life for both projects, and the probabilities for each year’s after tax cash flow is given in the table below.

Investment B Investment C

Probability

After Tax

Cash Flow

Probability

After Tax

Cash Flow

0.25

$20,000

0.30

$22,000

0.50

32,000

0.50

40,000

0.25

40,000

0.20

50,000

What is the expected value of each project’s annual after tax cash flow? Justify your answers and identify any conflicts between the IRR and the NPV and explain why these conflicts may occur.

Assuming that the appropriate discount rate for projects of this risk level is 8%, what is the risk-adjusted NPV for each project? Which project, if either, should be selected? Justify your conclusions.

Turn in your completed work to the Submissions Area by the due date assigned.

Assignment 1 Grading CriteriaMaximum PointsCorrectly calculated the cost of new equity and explained the calculations, as well as the advantages and disadvantages of using this type of financing for the firm. (CO4)20Correctly calculated the cost of new debt and explained the calculations, as well as the advantages and disadvantages of using this type of financing for the firm. (CO4)20Correctly calculated the weighted average cost of capital and explained how and why it is used in the capital budgeting process. (CO4)20Correctly calculated the annual cash flows for the projects and explained the methods used in the calculations. (CO1)44Evaluated the projects using the NPV method and came to the correct conclusions based on the decision rules for the NPV. (CO2)44Evaluated the projects using the IRR method and came to the correct conclusion based on the decision rules for the IRR. Identified any conflicts between the IRR and the NPV and explained why these conflicts may occur. (CO 3)44Correctly introduced risk into the evaluation by using the expected values as the cash flows and evaluated these cash flows using risk adjusted discounted rates. (CO 5)44Written in a clear, concise, and organized manner; demonstrated ethical scholarship in accurate representation and attribution of sources; displayed accurate spelling, grammar, and punctuation.64Total:300Due DateDec 11, 2017 11:59 PMHide Rubrics

Rubric Name: FIN401_W5A1_LASA2_Rubric

CriteriaUnsatisfactoryEmergingProficientExemplaryC1 Correctly calculated the cost of new equity, explained the calculations, and the advantages and disadvantages of using this type of financing for the firm. (CO4)

Calculations of the cost of new equity were incorrect.

Explanation of the advantages and disadvantages of using this type of financing for the firm was incomplete and made with inaccurate information.

Calculations of the cost of new equity were included but contained errors.

Explanation of the advantages and disadvantages of using this type of financing for the firm contained limited details

Calculations of the cost of new equity were correct or contained only minor, insignificant errors.

Explanation of the advantages and disadvantages of using this type of financing for the firm was accurate and included clear details

Calculations of the cost of new equity were correct.

Explanation of the advantages and disadvantages of using this type of financing for the firm was accurate, contained significant details and illustrated a thorough understanding of the concepts.

C2 Correctly calculated the cost of new debt, explained the calculations, and the advantages and disadvantages of using this type of financing for the firm. (CO4)

Calculations of the cost of new debt were incorrect.

Explanation of the advantages and disadvantages of using this type of financing for the firm was incomplete and made with inaccurate information

Calculations of the cost of new debt were included but contained errors.

Explanation of the advantages and disadvantages of using this type of financing for the firm contained limited details

Calculations of the cost of new debt were correct or contained only minor, insignificant errors.

Explanation of the advantages and disadvantages of using this type of financing for the firm was accurate and included clear details

Calculations of the cost of new debt were correct.

Explanation of the advantages and disadvantages of using this type of financing for the firm was accurate, contained significant details and illustrated a thorough understanding of the concepts.

C3 Correctly calculated the weighted average cost of capital and explained how and why it is used in the capital budgeting process. (CO4)

Calculations of the weighted average cost of capital were incorrect.

Incorrect explanation of how and why the weighted average is used in the capital budgeting process.

Calculations of the weighted average cost of capital were included but contained errors.

General explanation with some confusing statements and facts of how and why the weighted average is used in the capital budgeting process was presented.

Calculations of the weighted average cost of capital were correct or contained only minor, insignificant errors.

Clear and accurate explanation of how and why the weighted average is used in the capital budgeting process

Calculations of the weighted average cost of capital were correct.

Thorough and accurate explanation of how and why the weighted average is used in the capital budgeting process, which included elaborate statements and facts.

C4 Correctly calculated the annual cash flows for the projects and explained the methods used in the calculations. (CO1)

Calculations for the annual cash flows for the projects were incorrect.

Incorrectly explained the methods used in the calculations.

Calculations for the annual cash flows for the projects were included but contained errors.

Explained the methods used in the calculations, but with some errors.

Calculations for the annual cash flows for the projects were correct or contained only minor, insignificant errors.

Accurate explanation of the methods used in the calculations.

Calculations for the annual cash flows for the projects were correct.

In-depth explanation of the methods used in the calculations.

C5 Evaluated the projects using the NPV method and came to the correct conclusions based on the decision rules for the NPV. (CO2)

Improperly evaluated the projects using the NPV method.

Conclusion was incorrect based on the decision rules for the NPV.

Partially evaluated the projects using the NPV method.

Conclusion was partially correct, however overlooked critical details.

Accurately evaluated the projects using the NPV method.

Conclusion was correct, and method was clearly explained.

Thoroughly evaluated the projects using the NPV method.

Conclusion was correct, and extensively explained the method illustrating a thorough understanding of the concepts.

C6 Evaluated the projects using the IRR method and came to the correct conclusion based on the decision rules for the IRR. Identified any conflicts between the IRR and the NPV and explained why these conflicts may occur. (CO3)

Improperly evaluated the projects using the IRR method.

Conclusion was incorrect based on the decision rules for the IRR.

Partially evaluated the projects using the IRR method.

Conclusion was partially correct, however overlooked critical details.

Accurately evaluated the projects using the IRR method.

Conclusion was correct, and method was clearly explained.

Thoroughly evaluated the projects using the IRR method.

Conclusion was correct, and extensively explained the method illustrating a thorough understanding of the concepts.

C7 Correctly introduced risk into the evaluation by using the expected values as the cash flows and evaluated these cash flows using risk adjusted discounted rates. (CO5)

Incorrectly introduced risk in to the evaluation.

Improper evaluation given based on being unable to apply information to problem solving.

Generally introduced risk in to the evaluation.

General evaluation given which demonstrates basic understanding.

Clearly introduced risk in to the evaluation.

General evaluation given which demonstrates advanced understanding.

Effectively introduced risk in to the evaluation.

General evaluation given which demonstrates superior understanding.

C8 Organization Introduction Thesis Transitions Conclusion

Introduction is limited or missing entirely.

The paper lacks a thesis statement.

Transitions are infrequent, illogical, or missing entirely.

Conclusion is limited or missing entirely.

Introduction is present but incomplete or underdeveloped.

The paper is loosely organized around a thesis that may have to be inferred.

Transitions are sporadic.

Conclusion is present, but incomplete or underdeveloped.

Introduction has a clear opening, provides background information, and states the topic.

The paper is organized around an arguable, clearly stated thesis statement.

Transitions are appropriate and help the flow of ideas.

Conclusion summarizes main argument and has a clear ending.

Introduction catches the reader’s attention, provides compelling and appropriate background info, and clearly states the topic.

The paper is well organized around an arguable, focused thesis.

Thoughtful transitions clearly show how ideas relate.

Conclusion leaves the reader with a sense of closure and provides concluding insights.

C9 Usage and Mechanics Grammar Spelling Sentence structure

Writing contains numerous errors in spelling, grammar, and/or sentence structure that severely interferes with readability and comprehension.

Errors in spelling and grammar exist that somewhat interfere with readability and/or comprehension.

Writing follows conventions of spelling and grammar throughout. Errors are infrequent and do not interfere with readability or comprehension.

The paper is basically error free in terms of mechanics. Grammar and mechanics help establish a clear idea and aid the reader in following the writer’s logic.

C10 APA Elements Attribution Paraphrasing Quotations

No attempt at APA format.

APA format is attempted to paraphrase, quote, and cite, but errors are significant.

Using APA format, accurately paraphrased, quoted, and cited in many spots throughout when appropriate or called for. Errors present are somewhat minor.

Using APA format, accurately paraphrased, quoted, and cited throughout the presentation when appropriate or called for. Only a few minor errors present.

C11 Style Audience Word Choice

Writing often slips into first and/or second person.

Word choice is consistently inaccurate, unclear, or inappropriate for the audience.

Writing sometimes slips into first and/or second person.

Word choice is sometimes inaccurate, unclear, or inappropriate for the audience.

Writing remains in third person throughout writing.

Word choice is accurate, clear and appropriate for the audience.

Writing remains professional in third person throughout writing.

Word choice is precise, appropriate for the audience, and memorable.

Overall ScoreUnsatisfactoryEmergingProficientExemplary

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