UberZ Co is considering whether it should expand its self-driving cars division, or completely shut it down. To make this decision, the company paid McLindsay Co., a large consulting company, a fee of $20 million to evaluate the program, but they will refund half of that cost back to UberZ if it decides to shut down the project. McLindsay reported the following information about that the self-driving expansion project: The investment will have a 6-year horizon, and will require today an upfront cost of $200 million for assets. The assets are depreciated straight line to zero over a 20-year horizon. The company needs an upfront investment in net working capital of $2 million today, and then will maintain net working capital equal to 20% of sales. McLindsay also expects that the expansion will generate sales equal to $25 million the first year, and will grow by 25% per year until the project is liquidated in year six. Operating expenses will be 30% of sales. At the end of the investment horizon, the pre-tax liquidation (salvage) value from selling the equipment will be $120 million. You are an assistant to the CFO of the company and your first task is to advise UberZ whether the company should do the expansion or not. The CFO has provided you with the following data, which he believes may be relevant to your task (all the market data are current). The firm’s tax rate is 20%. The market data on UberZ’s securities is:
Debt (two types of bonds)
Bond A: 35,000,000 bonds outstanding, 6.5% coupon (semi-annual) with 20 years to maturity, selling at 90% of par. Assume the par value is $1,000.
Bond B: 6,000,000 bonds outstanding, 5% coupon (semi-annual) with 15 years to maturity selling at par. Assume the par value is $1,000.
Common stock
1,500,000,000 outstanding shares, selling for $50 per share;
Dividend (just paid) is $0.5 per share and is expected to increase its future dividends at a constant rate of 6%.
Assume the project’s riskiness is the same as the firm overall. The firm’s beta is 1.2.
Assume the risk-free rate is 1% and the market return is 10%.
Answer the following questions by copying the cells from your workbook and pasting it inside the box. Show your calculations and formulas for partial credit. DO NOT email pictures or screenshots of your work for partial credit, they do not count.
a. After taking into account for all relevant expenses, calculate cash flow from the assets (CFFA) for every year. (show table with values for partial credit).
b. Find UberZ’s capital structure weights.
c. Find UberZ’s cost of equity using the capital asset pricing model (CAPM).
d. Find UberZ’s cost of equity using the dividend growth model (DGM).
e. Find UberZ’s cost of debt.
f. What is UberZ’s weighted average cost of capital? (for the cost of equity use the average of values from CAPM and DGM.)
g. Compute the NPV and the IRR of the project.
h. Should the firm undertake the expansion project or not? Why?
Sample Solution
