Long-Term Working Capital Considerations

February 28, 2023February 28, 2023 Discipline: Business
Learning Goal: I’m working on a business question and need the explanation and answer to help me learn.

PART 3: LONG-TERM WORKING CAPITAL CONSIDERATIONS: CAPM, STOCK VALUATION, AND PROJECT EVALUATION TOOLS (1–2 PAGES, PLUS CALCULATIONS IN EXCEL)

  • CAPM and Required Return: The company has a beta of 1.1, and the closest competitor has a beta of 0.30. The required return on an index fund that holds the entire stock market is 11%. The risk-free rate of interest is 4.5%. By how much does your company’s required return exceed your competitor’s required return?
  • Constant Growth Valuation: The company is expected to pay a $1.80 per share dividend at the end of the year (i.e., D1 = $1.80). The dividend is expected to grow at a constant rate of 4% a year. The required rate of return on the stock, rs, is 10%. What is the stock’s current value per share?
  • Nonconstant Growth Valuation: The company recently paid a dividend, D0, of $2.75. It expects to have nonconstant growth of 18% for 2 years followed by a constant rate of 6% thereafter. The firm’s required return is 12%.
    • How far away is the horizon date?
    • What is the firm’s horizon, or continuing, value?
    • What is the firm’s intrinsic value today, P0?
  • Weighted Average Cost of Capital: The company has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 40%. The current stock price is P0 = $22.00. The last dividend was D0 = $2.25, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC?
  • Capital Budgeting Criteria: The company has an 11% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following cash flows:

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  • What is each project’s NPV?
  • What is each project’s IRR?
  • What is each project’s MIRR? (Hint: Consider Period 7 as the end of Project B’s life.)
  • From your answers to parts a, b, and c, which project would be selected? If the WACC was 18%, which project would be selected?
  • Construct NPV profiles for Projects A and B.
  • Calculate the crossover rate where the two projects’ NPVs are equal.
  • What is each project’s MIRR at a WACC of 18%?

EXECUTIVE SUMMARY (PAGE 1 OF YOUR REPORT)

Provide the company owner with a 1-page executive summary of your findings and recommendations. Address the following in your executive summary:

  • Briefly identify the purpose of your report.
  • Concisely summarize the results of your financial analysis of the company’s short- and long-term capital budget needs.
  • Synthesize your recommendations for how the company can raise money in the short-term and long-term to continue to add value to the organization.

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