ACCOUNTING-Using the company information provided below,

by | Aug 20, 2025 | Business

Instructions:
Using the company information provided
below, complete the following two tabs in this MS Excel Workbook:
–
Computation of the company’s estimated cost of equity capital, rE, and weighted average cost of capital,rWACC
– NPV
(capital budgeting) analysis of the company’s proposed investment in a new
Product B
The background paper, Capital
Budgeting and the Cost of Capital, provides useful
guidance for completing this assignment.
Based on the results
of your NVP Analysis, summarize your recommendations to management regarding
its contemplated introduction of the new product. Limit the length of your response to 75
words.
Replace the text in this cell with your response.
Company information:
North American Manufacturing Company is a
U.S.-based publicly traded company, whose stock is listed on a national
securities exchange.
Management looked up the stock’s historical
β (beta) at a popular financial Web search engine and obtained this
additional information:
Historical β
(beta) of the company’s common stock		 1.20
Current
market interest rate on the company’s new borrowings, rD		 0.095 (9.5
percent)
Company’s
combined effective income tax rate, t		 0.400 (40.0
percent)
Management’s
estimate of the expected rate of return on the “market portfolio,” rM		 0.125 (12.5
percent)
Management’s
estimate of the risk-free interest rate, rF		 0.040 (4.0
percent)
The balance sheet of the company as of its
most recent fiscal year end reflects management’s targeted capital structure
for the company.
That balance sheet reports the following
liability and shareholders’ equity balances:
Notes payable
to banks – current portion		 $ 10,000,000
Bonds payable
– current portion		 65,000,000
Notes payable
to banks – noncurrent portion		 375,000,000
Bonds payable
– noncurrent portion		 150,000,000
Common stock,
at par		 30,000,000
Additional
paid-in capital		 285,000,000
Treasury
stock		 (45,000,000)
Retained
earnings		 $ 130,000,000
Product-investment information:
Cost of
recently completed test-marketing of Product B		 $ 220,000
Costs of
previously incurred Product B research and development (R&D) costs		 $ 3,000,000
Management’s
estimate of the economic life of Product B 		5.0 years
Cost of
additional machinery and equipment (M&E) needed to manufacture Product
B		 $ 50,000,000
Fair value of
vacant building owned, to be used as Product B manufacturing facility		 $ 2,000,000 (Note 1)
Estimated
residual (fair) value of M&E at end of investment (Product B’s economic
life)		 $ 12,560,000
Note 1– The vacant building is fully depreciated; no significant
changes in the value of building over Product B investment period expected
As such, the projected net proceeds from the
assumed end-of-investment disposal of the building is $1,200,000 [i.e., $2.0
million x (1 – 0.40)]
Management’s projections:
Probability-weighted expected sales of
Product B:		 Year 1 Year 2 Year 3 Year 4 Year 5
Units 3,300,000 3,600,000 3,500,000 3,400,000 3,200,000
Revenue $ 64,600,000 $ 67,500,000 $ 60,000,000 $ 54,600,000 $ 48,200,000
Variable cost (VC) per unit $ 7.00 $ 7.30 $ 7.70 $ 8.00 $ 8.30
Incremental fixed costs (FC), other than depreciation of M&E $ 15,400,000 $ 15,720,000 $ 16,150,000 $ 14,800,000 $ 12,940,000
Erosion of existing Product A (contribution
margin) (Note 2)		 $ 5,600,000 $ 5,500,000 $ 5,400,000 $ 5,100,000 $ 4,200,000
Required end-of-year balance of net working
capital		 $ 5,600,000 $ 6,000,000 $ 5,400,000 $ 4,800,000 $ –
Note 2 – Projected adverse effects on the profitability of the
company’sexisting
Product A, resulting from introduction ofnew Product B
The facilitator will grade this assignment,
assigning up to 100 points for it as follows:		 Maximum Earned
Accuracy,
completeness, and clear presentation of:
– Business’
cost of capital, including related information input and computations		 25 25 points
–
Incremental cash flows attributable to proposed investment and capital
budgeting
analysis, including related information input and computations, and
investment
decision
reached		 75 75
Total
points		 100 100

Instructions: Use the information in the first worksheet
tab (Instructions and company/product information) to complete this tab. For each of a.
through c., below, show all computations in good
form and label properly all amounts presented.
a. Compute American Manufacuring Company’s
estimated cost of equity capital,rE
b. Compute the company’s targeted
capital structure (relative proportions of debt
and common equity capital).
c. Compute the company’s estimated weighted average cost of capital,rWACC
– 1 2 3 4 5

North American Manufacturing Company
Capital Budgeting
Analysis – Proposal for New Product B
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Cash flows
other than depreciation tax shield:
Machinery
and equipment (M&E):
(A) – Acquisition and
installation costs (“original tax basis”)
(B) – Proceeds from
disposal, net of capital gain tax
(Note 1)
(C) Opportunity cost of
existing facility, net of capital gain tax
(D) Incremental
(investment) or reduction in net working capital
(E) After-tax income before tax-basis “cost
recovery” of M&E (Note 2)
(F) Total cash flows other than depreciation tax shield
(G) Discount rate
(H) Discount factors 1.0000
(I) Discounted present
value (PV) of cash flows
(J) Total discounted
PV
Depreciation tax shield:
(K) Depreciation tax
shield on M&E		 $ –
(L) Discount rate
(M) Discount factors
(N) Discounted present
value (PV) of cash flows
(O) Total discounted PV
(P) Net present value
(NPV) of investment		 $ –
(Q) Total undiscounted net cash flows
(R) Total discounted net
cash flows
(S) Internal rate of
return (IRR)		 #NUM!
(T) Profitability index
(PI)		 #DIV/0!
Note 1 –Complete theComputation of Projected
Proceeds and Capital Gain Tax from Assumed End-of-Investment Sale of M&E, below
Note 2 –Complete theProjection of Income and
Depreciation Tax Shield, below
Product B Proposal – Projection of Income and Depreciation Tax Shield
Note 1 Year 1 Year 2 Year 3 Year 4 Year 5
(A) Projected number of
units produced and sold
(B) Projected sales
revenue
(C) Projected variable cost
(VC) per unit
(D) Projected total VC
(E) Projected incremental
fixed costs, other than
depreciation of M&E
(F) Total operating
expenses, other than
depreciation of M&E
(G) Erosion of existing
Product A (contribution margin)
(H) Income before tax-basis “cost
recovery” of M&E
(I) Combined effective
income tax rate
(J) Taxes on income before tax-basis “cost
recovery” of M&E
(K) After-tax income before tax-basis “cost
recovery” of M&E
(L) Tax-basis “cost
recovery” percentage of M&E		 Note 2 14.28% 24.49% 17.49% 12.50% 8.92%
(M) Tax-basis “cost
recovery” (L)
xOriginal cost of
(investment in) M&E:		 $ – $ – $ – $ – $ –
(N) Tax benefit of
tax-basis “cost recovery” (i.e.,depreciation tax shield)
(O) Cumulative tax-basis cost recovery of M&E Note 3 $ –
Note 1 – This capital budgeting analysis usesnominal (rather thanreal) cash flows and discount rates,
as is common practice
Note 2 – The cost
recovery percentages included in this analysis are those set forth by IRS
regulations for “7-year Class Life” property)
Note 3 – Use the
cumulative tax-basis cost recovery amount to compute the proceeds,net of capital gain tax, from
assumed disposal of M&E in Year 5 (below)
Proposal for New
Product B – Computation of Projected Proceeds and Capital Gain Tax from
Assumed End-of-Investment Sale of M&E
(A) Projected
fair value of M&E in final period of NPV analysis (assumed gross proceeds)		 $ –
(B) Original
cost (taxable basis) of M&E
(C) Cumulative
allowable “cost recovery” through final period of NPV analysis
(D) Adjusted
taxable basis of M&E
(E) Taxable
“capital gain”
(F) Combined
effective income tax rate
(G) Income tax
on “capital gain”
(H) Projected net proceeds from assumed
end-of-investment sale of M&E		 $ –

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