Zeus Corporation is a publicly traded company in the telecommunications industry. You are a senior financial management
Zeus – WACC and NPV Zeus Corporation is a publicly traded company in the telecommunications industry. You are a senior financial management advisor employed by the company to review its capital investment appraisal procedure and to provide advice on the acceptability of a significant new capital project. The project requires an immediate capital investment of $800 million on July 1, 2014 and the project will have the following revenues over the next five years:
Year-end Revenue ($ million)
June 30, 2015
June 30, 2016
June 30, 2017
June 30, 2018
June 30, 2019
680
900
900
750
320
Direct costs are 60% of revenues. Allocated indirect costs are $140 million for the first year of operations, and they will grow at 5% per year over the life of the project. Making this investment will mean that other work making a net contribution before indirect costs of $150 million each year for the first two years will not be able to be done. The capital expenditure of $800 million is to be paid immediately and the equipment will have a residual value after five years of operation of $10 million. The company depreciates plant and equipment on a straight-line basis for both tax and financial reporting purposes. Preconstruction design and contracting costs incurred over the previous three years total $50 million and will be charged to the project in the first year of operation. The company has a 30% tax rate and all taxes are to be paid in the following year. The company currently has $7,500 million of equity and $2,500 million of debt in issue quoted at current market values. The current cost of its debt finance is $LIBOR plus 180 basis points. $LIBOR is currently 5.40%, which is 40 basis points above the one month Treasury bill rate. The equity risk premium is 3.0% and the company’s beta is 1.33.
Required: A. What is the company’s Weighted Average Cost of Capital (WACC)? Show calculations. B. What is the project’s Net Present Value (NPV)? Should Zeus proceed with the project? Show calculations.
