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Franklin Corporation was considering adding additional production equipment to meet the growing demand for its product.
Franklin Corporation was considering adding additional production equipment to meet the growing demand for its product. Their financial analyst, Bill, was asked to do a capital expenditure analysis on the proposed production equipment acquisition. Bill was also asked to update the company's current WACC calculation.
The production equipment could be purchased for $12,000. The shipping cost was an additional $500. Installing the equipment would cost $1,500.
The equipment was expected to last seven years. It would be fully depreciated to zero for tax purposes on a straight line basis over the seven year useful life. Afterwards, it was expected that it could be sold for scrap for $800.
The equipment would be purchased and installed in January of 2019. Based on its production capacity, it was expected to produce 1,000 products per year that could all be sold for $10 each. The products would cost $5 each to produce them.
Additional incremental SG&A expenses were estimated to be $800 in the first year and thereafter increase by the inflation rate (see below). Also, an accountant informed Bill that if the production equipment was acquired and used, an additional $500 a year of existing fixed corporate SG&A expenses would be allocated to the production department.
Future inflation was expected to be 1% per year. The corporate income tax rate was 30%. The production and sale of the additional products was expected to create net working capital equal to 15% of the additional sales.
The company did not have a targeted capital structure. The book value of its equity was $500,000. It had $800,000 in long term debt, $200,000 in short term debt and $400,000 in accounts payable. The company had outstanding 100,000 shares of stock that were trading at $10 a share. The company's beta was 1.1. The market value of the company's debt equaled its book value.
Franklin's long term debt had a current yield to maturity of 8%. The current interest rate on Franklin's short term debt was 6%. U.S. long term treasury bonds were currently yielding 3%. Checking some financial data sources, Bill found that the historical annual return on stocks had exceeded the risk free returns by 4%.
Your Assignment:
Calculate the WACC for the Franklin Corporation. Show each step of your calculation. For the debt weight calculation, use the recommended approach of including short term debt as part of the debt weight.
Do a capital expenditure analysis of the proposed project. You will need to develop your own Excel spreadsheet to perform this analysis.
