ABC Enterprise is considering the purchase of a new assembly line, costing $300,000. The new assembly line has a 5-year tax life and will be depreciated under straight-line. The firm estimates that in 4 years the assembly line can be salvaged for $40,000. For the next 4 years the new assembly line will increase output and thereby raises sales by $15,000 per year and will reduce production expenses by $5,000 per year. The firm also needs an initial decrease in net working capital of $20,000. Assume that ABC’s tax rate is 34% and ABC Enterprise has the following information on its equity and bonds:
Common stock: 2 million shares outstanding, currently selling for $30 per share. ABC Enterprise expects to pay dividend of $3.00 next year and the dividend growth rate is expected to be 5%.
Bonds: 80,000 bonds outstanding, $1,000 face value for each bond, 7% coupon with 10 years to maturity, and selling for $1,150.00. The bonds pay coupons semi- annually.
ABC Enterprise plans to raise the funds needed to purchase the assembly line by issuing new common stocks and bonds.
The flotation costs of the new common stock would be 8% of the amount raised. The flotation costs of the new bonds would be 4% of the proceeds.
(a) What is the WACC of ABC Enterprise?
(b) What is the NPV of the project?
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