Wacc Solution Essay

763 words - 3 pages

WACC Solution(A)The payback is 35,000/5,000= 7 years Computation of the NPV : 15 NPV= -35,000 + Σ 5,000 / ( 1 + 12%)^ 15 i=1 NPV = $- 947. 67 Computation of the IRR : 15 0= -35,000 + Σ 5,000 / ( 1 + IRR)^ 15 i=1 IRR= 11.49%The NPV of this project is negative and the IRR is lower than the Cost of Capital of 12% so Rainbow products shouldn't go for this investment opportunity.(B)Based on the perpetuity formula we can calculate the present value:Computation of the PV:PV= Cash flow per year/ cost of capital=4,500 / 0.12= $37,500Computation of the NPV:NPV= -Initial investment + PV= -35,000 + 37,500NPV=$2,500Rainbow products could buy this machine with the service contract as it has a positive NPV of $2,500.1.(C)Computation of the PV :PV= C/ k-gIn this case C (end of year perpetuity payout) = 5,000-1,000= $4,000 k= 12%, discount rateg= 4%, growing rate at perpetuityPV= 4,000 / (0.12-0.04) = $50,000Computation of the NPV :NPV= -35,000+ 50,000 = $15,000The rainbow products company should invest in this project because its NPV is largely positive because of the reinvestment of 20% of the annual cost, even though this is in a very long term vision..Questions CoveredWhat factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why?How can the Capital Asset Pricing Model be used to estimate the cost of capital for a real (not financial) investment decision?What is the estimate of the risk-free rate that should be employed in calculating the cost of capital for Ameritrade?What is the estimate of the market risk premium that should be employed in calculating the cost of capital at Ameritrade?In principle, what are the steps for computing the asset beta in the CAPM for the purposes of calculating the cost of capital for a project?Ameritrade does not have a beta estimate because the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade's planned advertising and technology investments?Using the stock price and returns data in Exhibits 4 and 5, and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms.How should Joe Ricketts,...

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