I answred question 1 below butneed help with question 2. I've included my answer to question 1 since it is needed to do question 2. 1. We calculated the market value of equity on Sangria's balance sheet by multiplying its current stock price ($7.50) by 100 million, the number of its outstanding shares. The company's future prospects are good, so the stock is trading above book value ($7.50 vs. $5.00 per share). However, interest rates have been stable since the firm's debt was issued and the book and market values of debt are in this case equal. Sangria's cost of debt (the market interest rate on its existing debt and on any new borrowing) is 6%. Its cost of equity (the expected rate of return demanded by investors in Sangria's stock) is 12.4%. The market-value balance sheet shows assets worth $1,250 million. Of course we can't observe this value directly, because the assets themselves are not traded. But we know what they are worth to debt and equity investors ($500 + 750 = $1,250 million). This value is entered on the left of the market-value balance sheet. Sangria is consistently profitable and pays taxes at the marginal rate of 35%. Question 1: What is Sangria's after-tax WACC? 9% using book value 2. Using Sangria's WACC to Value a Project Sangria's enologists have proposed investing $12.5 million in the construction of a perpetual crushing machine, which (conveniently for us) never depreciates and generates a perpetual stream of earnings and cash flow of $1.731 million per year pre-tax. The project is average risk of the overall company. Sangria will maintain the same capital structure for this project. Sangria pays taxes at the marginal rate of 35%. MARKET VALUE Asset Value 1,250,000 Debt 500,000 Equity 750,000 Stock Price 7.5 Outstanding Shares 1,000,000 Cost of Debt 6% Cost of Equity 12% Tax Rate 35% Debt Ratio (D/V) 40% Equity Ration (E/V) 60% WACC Using Market 9% Question 2: Should Sangria take this project?
I answred question 1 below butneed help with question 2. I've included my answer to question 1 since it is needed to do question 2.
1. We calculated the market value of equity on Sangria's balance sheet by multiplying its current stock price ($7.50) by 100 million, the number of its outstanding shares. The company's future prospects are good, so the stock is trading above book value ($7.50 vs. $5.00 per share). However, interest rates have been stable since the firm's debt was issued and the book and market values of debt are in this case equal.
Sangria's cost of debt (the market interest rate on its existing debt and on any new borrowing) is 6%. Its
The market-value balance sheet shows assets worth $1,250 million. Of course we can't observe this value directly, because the assets themselves are not traded. But we know what they are worth to debt and equity investors ($500 + 750 = $1,250 million). This value is entered on the left of the market-value balance sheet.
Sangria is consistently profitable and pays taxes at the marginal rate of 35%.
Question 1: What is Sangria's after-tax WACC? 9% using book value
2. Using Sangria's WACC to Value a Project
Sangria's enologists have proposed investing $12.5 million in the construction of a perpetual crushing machine, which (conveniently for us) never depreciates and generates a perpetual stream of earnings and cash flow of $1.731 million per year pre-tax.
The project is average risk of the overall company. Sangria will maintain the same capital structure for this project. Sangria pays taxes at the marginal rate of 35%.
| MARKET VALUE | |
| Asset Value | 1,250,000 |
| Debt | 500,000 |
| Equity | 750,000 |
| Stock Price | 7.5 |
| Outstanding Shares | 1,000,000 |
| Cost of Debt | 6% |
| Cost of Equity | 12% |
| Tax Rate | 35% |
| Debt Ratio (D/V) | 40% |
| Equity Ration (E/V) | 60% |
| WACC Using Market | 9% |
Question 2: Should Sangria take this project?
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