rate to evaluate the project. The following information about the company's sources of financing is provided below: a. The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. b. Vigour Pharmaceuticals has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue. c. The company's preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding. d. There are 300,000 shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95. Other relevant information is as follows: 1. The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds. ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax.
rate to evaluate the project. The following information about the company's sources of financing is provided below: a. The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. b. Vigour Pharmaceuticals has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue. c. The company's preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding. d. There are 300,000 shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95. Other relevant information is as follows: 1. The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds. ii. Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax.
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 10P
Related questions
Question
Why should the cost of capital used in capital budgeting be calculated as a weighted average of the capital component rather than the cost of the specific financing used to fund a particular project? Please explain using the images attached.
![Vigour Pharmaceuticals Ltd. is considering investing in a new
production line for its pain-reliever medicine for individuals who
suffer from cardio vascular diseases. The company has to invest in
equipment which costs $2,500,000 and will be depreciated under the
MACRS system for a 5-year asset class. It is expected to have a scrap
value of $700,000 at the end of the project. Other than the equipment,
the company needs to increase its cash and cash equivalents by
$100,000, increase the level of inventory by $30,000, increase
accounts receivable by $250,000 and increase account payable by
$50,000 at the beginning of the project. Vigour Pharmaceuticals expect
the project to have a life of five years. The company would have to
pay for transportation and installation of the equipment which has an
invoice price of $450,000.
The company has already invested $75,000 in Research and Development
and therefore expects a positive impact on the demand for the new
pain-reliever. Expected annual sales for the product in the first
three years are $600,000 and $850,000 in the following two years. The
variable costs of production are projected to be $267,000 per year in
years one to three and $375,000 in years four and five. Fixed overhead
is $180,000 per year over the life of the project.
The introduction of the new line of pain reliever will cause a net
decrease of $50,000 in profit contribution due to a decrease in sales
of the other lines of pain relievers produced by the company. By
investing in the new product line Vigour Pharmaceuticals would have
to use a packaging machine which the company already has. It is fully
depreciated and could be sold at the end of the project for $350,000
after-tax in the equipment market.
The company's financial analyst has advised Vigour Pharmaceuticals to
use the weighted average cost of capital as the appropriate discount](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fc3731bbb-6bff-44d9-8b6d-64fecd531558%2Fd2def5e2-0da2-40bb-a763-75a10af106ec%2Ftf878e_processed.png&w=3840&q=75)
Transcribed Image Text:Vigour Pharmaceuticals Ltd. is considering investing in a new
production line for its pain-reliever medicine for individuals who
suffer from cardio vascular diseases. The company has to invest in
equipment which costs $2,500,000 and will be depreciated under the
MACRS system for a 5-year asset class. It is expected to have a scrap
value of $700,000 at the end of the project. Other than the equipment,
the company needs to increase its cash and cash equivalents by
$100,000, increase the level of inventory by $30,000, increase
accounts receivable by $250,000 and increase account payable by
$50,000 at the beginning of the project. Vigour Pharmaceuticals expect
the project to have a life of five years. The company would have to
pay for transportation and installation of the equipment which has an
invoice price of $450,000.
The company has already invested $75,000 in Research and Development
and therefore expects a positive impact on the demand for the new
pain-reliever. Expected annual sales for the product in the first
three years are $600,000 and $850,000 in the following two years. The
variable costs of production are projected to be $267,000 per year in
years one to three and $375,000 in years four and five. Fixed overhead
is $180,000 per year over the life of the project.
The introduction of the new line of pain reliever will cause a net
decrease of $50,000 in profit contribution due to a decrease in sales
of the other lines of pain relievers produced by the company. By
investing in the new product line Vigour Pharmaceuticals would have
to use a packaging machine which the company already has. It is fully
depreciated and could be sold at the end of the project for $350,000
after-tax in the equipment market.
The company's financial analyst has advised Vigour Pharmaceuticals to
use the weighted average cost of capital as the appropriate discount
![rate to evaluate the project. The following information about the
company's sources of financing is provided below:
a. The company will contract a new loan in the sum of $2,000,000
that is secured by machinery and the loan has an interest rate
of 6 percent.
b. Vigour Pharmaceuticals has also issued 4,000 new bond issues
with an 8 percent coupon, paid semi-annually and matures in 10
years. The bonds were sold at par, and incurred floatation cost
of 2 percent per issue.
c. The company's preferred stock pays an annual dividend of 4.5
percent and is currently selling for $60, and there are 100,000
shares outstanding.
d. There are 300,000
shares of common
stock outstanding, and they are currently selling for $21 each.
The beta on these shares is 0.95.
Other relevant information is as follows:
i. The 20-year Treasury Bond rate is currently 4.5 percent and you
have estimated market-risk premium to be 6.75 percent using the
returns on stocks and Treasury bonds.
ii.
Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In
the event of a negative taxable income, the tax is computed as
usual and is reported as a negative number, indicating a
reduction in loss after tax.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fc3731bbb-6bff-44d9-8b6d-64fecd531558%2Fd2def5e2-0da2-40bb-a763-75a10af106ec%2Fu0wz1vn_processed.png&w=3840&q=75)
Transcribed Image Text:rate to evaluate the project. The following information about the
company's sources of financing is provided below:
a. The company will contract a new loan in the sum of $2,000,000
that is secured by machinery and the loan has an interest rate
of 6 percent.
b. Vigour Pharmaceuticals has also issued 4,000 new bond issues
with an 8 percent coupon, paid semi-annually and matures in 10
years. The bonds were sold at par, and incurred floatation cost
of 2 percent per issue.
c. The company's preferred stock pays an annual dividend of 4.5
percent and is currently selling for $60, and there are 100,000
shares outstanding.
d. There are 300,000
shares of common
stock outstanding, and they are currently selling for $21 each.
The beta on these shares is 0.95.
Other relevant information is as follows:
i. The 20-year Treasury Bond rate is currently 4.5 percent and you
have estimated market-risk premium to be 6.75 percent using the
returns on stocks and Treasury bonds.
ii.
Vigour Pharmaceuticals has a marginal tax rate of 35 percent. In
the event of a negative taxable income, the tax is computed as
usual and is reported as a negative number, indicating a
reduction in loss after tax.
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