North Sea Oil has compiled the following data relative to current costs of its basic sources of external capitals, long-term debt, preferred stock, and common stock equiy.
Source of capital Cost
Long-Term Debt 7%
Preffered Stock 19%
Common Stock and Retained Earnings 20%
Below are the company’s target capital structure proportion used in calculating the weighted average cost of capital.
Source of Capital Target Capital Structure
Long Term Debt .25
Preferred Stock .25
Common Stock and Retained Earning .50
North Sea has the opportunity to invest in the following projects:
Project A Project B
Initial Investment $130,000 $85,000
Year Cash inflows Cash inflows
1 $25,000 $40,000
2 $35,000 $35000
3 $45,000 $30,000
4 $50,000 $10,000
5 $55,000 $5,000
Using the WACC to calculate the NPV and evaluate the IRR, which project should be implemented? (you may also wish to include payback to further support your answer).
Assuming the project(s) is implemented using equity financing, the capital structure changes to:
Source of Capital New capital structure after project implementation
Long term debt .20
Preferred stock .20
Common stock and retained earnings .60
Calculate the New WACC and briefly discuss in your report if this new WACC and capital structure might signal the market and investors.
Capital Budgeting Case – From the given case information, calculate the firm’s
WACC then use the WACC to calculate NPV and evaluate IRR for proposed capital
budgeting projects with a capital rationing constraint. After you choose the
project(s), recalculate the capital structure based on the assumption that the
project(s) are implemented and determine if the new capital structure will
signal the investors either positively, negatively, or not at all. Write a
business report on your findings. Include an executive summary and appendices if
applicable.
Source of capital Cost
Long-Term Debt 7%
Preffered Stock 19%
Common Stock and Retained Earnings 20%
Below are the company’s target capital structure proportion used in calculating the weighted average cost of capital.
Source of Capital Target Capital Structure
Long Term Debt .25
Preferred Stock .25
Common Stock and Retained Earning .50
North Sea has the opportunity to invest in the following projects:
Project A Project B
Initial Investment $130,000 $85,000
Year Cash inflows Cash inflows
1 $25,000 $40,000
2 $35,000 $35000
3 $45,000 $30,000
4 $50,000 $10,000
5 $55,000 $5,000
Using the WACC to calculate the NPV and evaluate the IRR, which project should be implemented? (you may also wish to include payback to further support your answer).
Assuming the project(s) is implemented using equity financing, the capital structure changes to:
Source of Capital New capital structure after project implementation
Long term debt .20
Preferred stock .20
Common stock and retained earnings .60
Calculate the New WACC and briefly discuss in your report if this new WACC and capital structure might signal the market and investors.
Capital Budgeting Case – From the given case information, calculate the firm’s
WACC then use the WACC to calculate NPV and evaluate IRR for proposed capital
budgeting projects with a capital rationing constraint. After you choose the
project(s), recalculate the capital structure based on the assumption that the
project(s) are implemented and determine if the new capital structure will
signal the investors either positively, negatively, or not at all. Write a
business report on your findings. Include an executive summary and appendices if
applicable.
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