Provide only   cost of capital, operating cash flows, net working capital requirements, terminal year cash flow adjustments, capital budgeting techniques: NPV, IRR, Profitability Index, and Payback. (As mentioned)
Solution:-
Computation of cost of capital (WACC):-
Debt ratio = 40%
Marginal tax rate = 40%
Forecasted average inflation = 3.50%
Current bond's yield to maturity = 6.50%
Current 10 year treasury notes yield i.e. Risk free rate of return (Rf) = 4%
Market risk premium (Mp) = 5.50%
Beta (β) = 1.15
Debt ratio (i.e. 40%) = Total Debt/Total Capital Employed
= 40/100
Total Capital employed = 100
Debt capital ( D ) = 40
Equity Capital ( E ) = 60
Cost of debt (kd) = Current yield on bond*(1-tax rate)
= 6.5%*(1-40%)
= 3.90%
Cost of equity (Ke) = Rf+(β*Mp)
= 4%+(1.15*5.5%)
= 10.33%
Cost of Capital (WACC) (Ko) = (Kd*(D/(D+E)))+(Ke*(E/(E+D)))
= (3.9%*(40/100))+(10.33%*(60/100))
= 7.76%
Cost of capital of Road King Trucks is 7.76% (as calculated above).
CHOICE OF ENGINE:-
Detroit Engine Marcus Engines
Initial Cost 20000 18000
Warranty cost per year 1000 1500
Warrranty period 5 year 5 year
Computation of Present value of total cost of engine \$24,018.09 \$24,027.14
It is better to Purchase Detroit Engine as it will cost lesser then Marcus engine.
Computation of Capital budgeting techniques:-
No. of busses to be sold 11000
Sales price per bus 220000
Labor cost per bus 50000
Component and parts per bus 95000
Cost of Engine per bus 24018.09
Average warranty cost per bus 1000.00
Waranty period 5 year
Present value of Average waranty cost 4018.09
Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Initial investment \$1,000,000,000.00
Sales \$2,420,000,000 \$2,504,700,000 \$2,592,364,500 \$2,683,097,258 \$2,777,005,662 \$2,874,200,860 \$2,974,797,890 \$3,078,915,816 \$3,186,677,869 \$3,298,211,595 \$3,413,649,001 \$3,533,126,716 \$3,656,786,151 \$3,784,773,666 \$3,917,240,744...