Cost of Debt Lookup Table Analysis and Financial Computation ✓ Solved

To update this spreadsheet, enter the following Cost of Debt Lookup Table (based on standard deviation in stock prices):

Long Term Treasury bond rate = 3.04% Standard Deviation Basis Spread Risk Premium to Use for Equity = 5.00% US implied premium 0 0.25 0.50% Global Default Spread to add to cost of debt = 0.00% None for the US 0.25 0.5 1.00% Do you want to use the marginal tax rate for cost of debt? No 0.5 0.65 1.50% If yes, enter the marginal tax rate to use 40% 0.65 0.8 2.00% 0.8 0.9 2.50% 0..00% .00% Industry Name Number of Firms Beta Cost of Equity E/(D+E) Std Dev in Stock Cost of Debt Tax Rate After-tax Cost of Debt D/(D+E) Cost of Capital.

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Steps for Computation: 1. Complete the "Fundamental Statistics" section 2. Complete the Amortization table. Same as you did in Buy-Rent assignment 3. Complete the Rev/Net Inc Table 4. Complete the FCFE by Year 5. Compute PV of Cash Flows 6. Compute NPV.

FUNDAMENTAL STATISTICS: Estimated Cost of Equity 9.78% Derived as follows: R(rf) 5% Beta 0.869 Today's Beta will be different Risk Prem 5.50% Debt Rating A+ Def Spread 0.80% Market Interest Rate 5.80% Marginal Tax Rate 35% After Tax Cost of Debt 0..77%. Initial CapEX (T0 - New Store) $20M. Debt Issued $5M. Initial Investment in WC $3.2M. WC in Y1 (% of Rev) 8%. WC in Y2-Y10 (change in Rev) 8%. Life of Store (yrs) 10. Residual Value at Y10 $7.5M.

Step 2: Amortization Table for Debt.

Step 3: Revenues/Net Income calculations for each year.

Step 4: FCF and NPV calculations.

Future CFs To Equity PV at COE: Cost of Equity 9.78%. Rev growth 5%. Use calculations to compute interest and repayment schemes.

Paper For Above Instructions

The cost of debt is a critical component of a firm's capital structure, representing the interest rate paid by the company on its borrowed funds. This analysis will detail the components that make up the cost of debt and present a financial computation through a systematic approach to estimating the cost of debt, equity figures, cash flows, and the overall net present value (NPV) for an investment project.

Cost of Debt Computation

Estimating the cost of debt involves several economic indicators, which include the long-term Treasury bond rate, the spread attributable to risk, and any adjustments needed based on the marginal tax rate of the entity. As per the given information, the long-term Treasury bond rate stands at 3.04%. This rate is critical as it serves as a baseline for evaluating the company’s risk premium.

The calculation of the cost of debt, excluding the tax benefits, can be expressed mathematically as follows:

  • Cost of Debt = Long-term Treasury rate + Risk Premium + Default Spread.

Given the provided data, where the risk premium stands at 5.00% and the default spread is stated as 0.80%, we can compute the raw cost of debt:

  • Cost of Debt = 3.04% + 5.00% + 0.80% = 8.84%

Next, since the marginal tax rate is acknowledged as 35%, we apply this to adjust our computation for interest expenses that effectively reduce the cost borne by the firm:

  • After-tax Cost of Debt = Cost of Debt \* (1 - Marginal Tax Rate)

  • After-tax Cost of Debt = 8.84% * (1 - 0.35) = 5.74%

Equity Cost Estimation

The analysis of equity entails determining the cost of equity, which, as presented, amounts to 9.78%. The cost of equity represents the return required by equity investors given the risks associated with owning a stock. This rate can also be derived using the Capital Asset Pricing Model (CAPM), which incorporates the risk-free rate, the stock's beta, and the equity market risk premium.

For our computation, an estimated beta of 0.869 has been supplied, which reflects the sensitivity of the stock's returns relative to the market. As inputs, we utilize a risk-free rate of 5.00% and a risk premium of 5.50%:

  • Cost of Equity = Risk-free Rate + (Beta * Market Risk Premium).

Thus, we compute:

  • Cost of Equity = 5.00% + (0.869 * 5.50%)

  • Cost of Equity = 5.00% + 4.78% = 9.78%

NPV Calculation

Subsequently, to evaluate the project's financial viability, the NPV of projected cash flows must be determined. NPV calculates the present value of cash inflows against the cash outflows during the investment period. Below are the steps and calculations employed for clarity:

  1. Estimate future cash flows generated by the project over its lifespan, factoring in revenue growth and operating expenses.

  2. Discount each annual cash flow back to present value using the cost of equity as the discount rate.

  3. Subtract the initial investment costs from the total present value of cash flows to arrive at the NPV.

Each annual cash flow encapsulates various components, such as revenues, operating expenses, and capital expenditures, alongside the salvage value at the end of the project’s life span.

Conclusion

This analysis synthesizes crucial components of corporate finance involving the cost of equity and debt, along with vital profitability metrics such as NPV. It illustrates the fundamental procedures in calculating these metrics, ensuring a comprehensive evaluation of potential investment decisions.

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