FINC-UB 7 Corporate Finance - New York University. MIDTERM EXAM Fall 2020.

FINC-UB 7 Corporate Finance - New York University You run Wereinit, a profitable conglomerate, that is considering an investment in a gelati project. You have the following data obtained after spendi ng $3 million researching the 2 industry. You believe you can instantaneously capture 3% of the $500 million market. But this business will cannibalize your current food sales by 10%. On the other hand, your new non-food sales figure would increase to $175 million – although you realize that that figure was about to increase 10% even without the project. You will need capital of $24 million for this business. This includes Net Working Capital which is always 20% of Sales. You can expense 20% of this CAPX and the rest will be depreciated straight-line over the life of the project. This CAPX is on top of the $6 million spent on assets intended for this project three years ago that is about to be depreciated for the last time. If you decide against the project, you can only recoup one-half of this investment. On top of these assets, you had bought land for $3 million that is now valued at only $2 million. You only need this land for the project so if you decide against the project you would sell the land. Costs of Goods Sold are always 60% of sales. There is an additional operating expense of $0.5 million annually for the new investment on top of the 8 new gelati employees you must hire at an average salary plus associated costs of $50,000 each -- as well as a liaison to headquarters at $100,000/year. The liaison will be included in your overhead allocation of $1 million. There are no other changes in revenues or costs. These numbers are the expected figures for each year throughout the life of the project. The IRS assigns a Corporate Tax Rate of 40% and allows the CAPX investment to be fully straight-line depreciated over 8 years. The project will last only 8 years. At that time, you expect to sell the entire business including the land for $13 million. Assume all ongoing cash flows occur at yearend, (immediate costs occur at time 0). And the Market Risk Premium is 6. You also have the following financial data: Treasury Security 3-month T-bill 1-Year T-bond 5-year T-bond 8-year T-bond Rate2%4%5%6% AA Corporate Bonds 8% Wereinit PercheNo SanCrispino Total Sales $200 Million $0 $25 Million $25 Million $50 Million $ 0 Million $30 $20 $500 Million $800 Million AA 1.4 $35 $30 $60 Million $90 Million AA 1.1 $30 Million Gelati Sales $28 Million Other Food Sales $2 Million Stock Price (Market) $50 Stock Price (Book) $40 Book Value of Equity $80 Million Book Value of Firm $110 Million Bond Credit Rating AA Beta (Yahoo Finance) 1.0 3 Given an appropriately borrowed $10 million at your current bond rating to fund this project, show whether you should invest using DCF analysis. (60 points)