Course Project Part II
You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return of 15% (Task 4) and (2) the firm’s cost of capital (Task 5).
Task 4. Capital Budgeting for a New Machine
A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:
Year 1 $1,100,000
Year 2 $1,450,000
Year 3 $1,300,000
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5. Provide examples of at least one of the following as it relates to the project: (5 pts each)
a. Sunk Cost
Air Jet hiring a consulting group to come in and evaluate the utility and feasibility of acquiring a new machine. Even if Air Jet does not get the new machine, this money has already been spent and cannot be recovered.
b. Opportunity cost
Air Jet Best Parts, Inc. markets a tester software for its company and gives it away to a number of other businesses for free but, the software only has limited capabilities. Air Jet Best Parts, Inc. advertise the full version at a minimal cost, and Air Jet Best Parts, Inc. hopes that these businesses will find a needed use of their product, , due to its lack of functionality. Air Jet Best Parts, Inc. hopes this upgrade will happen as businesses become more familiar with their software.
Air Jet Best Parts, Inc. stocks were trading at $125.00 a share for the last 7 days, and because of a mass recall of some defective parts, Air Jet Best Parts, Inc. shares have dropped stead by 10% for the past two days, which is known as erosion or depreciation of assets.
6. Explain how you would conduct a scenario and sensitivity analysis of the project. What would be some project-specific risks and market risks related to this project? (20 pts)
Once this NPV Net Present Value is calculated, the factor which reduces the NPV Net Present Value to negative values should be incorporated to determine the factors in which may be sensitive for the project.
Task 5: Cost of Capital
AirJet Best Parts Inc. is now considering that the appropriate discount rate for the new machine should be the cost of capital and would like to determine it. You will assist in the process of obtaining this rate.
1. Compute the cost of debt. Assume AirJet Best Parts Inc. is considering issuing new bonds. Select current bonds from one of the main competitors as a benchmark. Key competitors include Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman Corporation.
a. What is the YTM of the competitor’s bond? You may use a number of sources, but we recommend Morningstar. Find the YTM of one 15 or 20 year bond with the highest possible creditworthiness. You may assume that new bonds issued by AirJet Best Parts, Inc. are of similar risk and will require the same return. (5 pts)
Yield to maturity YTM of competitor bond = 8.92 %
after-tax cost of debt if the tax rate is 34%= 8.92x.66 = 5.50%
b. What is the after-tax cost of debt if the tax rate is 34%? (5 pts)
5.50% x 34% = 1.87% - 5.50% =3.63%
c. Explain what other methods you could have used to find the cost of debt for AirJet Best Parts Inc.(10 pts)
The Yield to maturity (YTM) method could have been used, which would of allowed AirJet Best Parts Inc. to compute the actual YTM of the new bond issue by incorporating all the cash flow associated with the issue, assuming that the bond will be held until it’s maturity and...