Page of 3 ZOOM Identifying Relevant Cash Flows Suppose a beverage company is considering adding a new product line. Curr
Posted: Wed Mar 30, 2022 3:48 pm
Page
of 3
ZOOM
Identifying Relevant Cash Flows
Suppose a beverage company is considering adding a new product
line.
Currently the company sells apple juice and they are considering
selling a fruit drink.
The fruit drink will have a selling price of $1.00 per jar. The
plant has excess capacity in a
fully depreciated building to process the fruit drink. The fruit
drink will be discontinued in four years.
The new equipment is depreciated to zero using straight line
depreciation. The new fruit drink requires
an increase in working capital of $25,000 and $5,000 of this
increase is offset with accounts payable.
Projected sales are 150,000 jars of fruit drink the first year,
with a 20 percent growth for the following years.
Variable costs are 55% of total revenues and fixed costs are
$10,000 each year. The new equipment costs
$195,000 and has a salvage value of $25,000.
Bond Information:
The corporate tax rate is 35 percent and the company currently has
1,000,000 shares of stock outstanding
at a current price of $15. The company also has 50,000 bonds
outstanding, with a current price of $985. The
bonds pay interest semi-annually at the coupon rate is 6%. The
bonds have a par value of $1,000 and will
mature in twenty years.
Equity Information:
Even though the company has stock outstanding it is not publicly
traded. Therefore, there is no publicly
available financial information. However, management believes that
given the industry they
are in the most reasonable comparable publicly traded company is
National Beverage Company (ticker symble
is FIZZ). In addition, management believes the S&P 500 is a
reasonable proxy for the market portfolio.
Therefore, the cost of equity is calculated using the beta from
FIZZ and the market risk premium based on the
S&P 500 annual expected rate of return. (The best estimate for
the expected return on the market is to look at
long run historical averages of the stock market. I provided you
the historical long run average in Module 6
under page Historical Asset Averages. Next go to US Treasury Yield
website to obtain current 3 month T-bill rate.)
WACC is then calculated using the CAPM and beta estimate as
discussed for FIZZ since it is in the same industry.
Clearly show all your calculations and sources for all parameter
estimates used in the WACC.
Please add on the working notes to it as well
of 3
ZOOM
Identifying Relevant Cash Flows
Suppose a beverage company is considering adding a new product
line.
Currently the company sells apple juice and they are considering
selling a fruit drink.
The fruit drink will have a selling price of $1.00 per jar. The
plant has excess capacity in a
fully depreciated building to process the fruit drink. The fruit
drink will be discontinued in four years.
The new equipment is depreciated to zero using straight line
depreciation. The new fruit drink requires
an increase in working capital of $25,000 and $5,000 of this
increase is offset with accounts payable.
Projected sales are 150,000 jars of fruit drink the first year,
with a 20 percent growth for the following years.
Variable costs are 55% of total revenues and fixed costs are
$10,000 each year. The new equipment costs
$195,000 and has a salvage value of $25,000.
Bond Information:
The corporate tax rate is 35 percent and the company currently has
1,000,000 shares of stock outstanding
at a current price of $15. The company also has 50,000 bonds
outstanding, with a current price of $985. The
bonds pay interest semi-annually at the coupon rate is 6%. The
bonds have a par value of $1,000 and will
mature in twenty years.
Equity Information:
Even though the company has stock outstanding it is not publicly
traded. Therefore, there is no publicly
available financial information. However, management believes that
given the industry they
are in the most reasonable comparable publicly traded company is
National Beverage Company (ticker symble
is FIZZ). In addition, management believes the S&P 500 is a
reasonable proxy for the market portfolio.
Therefore, the cost of equity is calculated using the beta from
FIZZ and the market risk premium based on the
S&P 500 annual expected rate of return. (The best estimate for
the expected return on the market is to look at
long run historical averages of the stock market. I provided you
the historical long run average in Module 6
under page Historical Asset Averages. Next go to US Treasury Yield
website to obtain current 3 month T-bill rate.)
WACC is then calculated using the CAPM and beta estimate as
discussed for FIZZ since it is in the same industry.
Clearly show all your calculations and sources for all parameter
estimates used in the WACC.
Please add on the working notes to it as well