Corporate Finance NVP Term Paper

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Corporate Finance

Cascade Water has the following cost of capital. The total value of the company is apparently going to be valued using market value. Normally, you wouldn't do that but ok. The market value of common stock is $1.26 billion. The market value of the debt is $461, 695, 000, which gives the total market value of the company as $1,721,695,000. The weight of equity is therefore 73.1%, which means that the weight of the debt is 26.9%.

The weighted average cost of capital is calculated as the weight of equity multiplied by the cost of equity, plus the weight of debt multiplied by the cost of debt. The cost of debt can be determined using a yield to maturity calculator. For this to work properly, you would need to know how much time is left to maturity, but since we don't have that we'll have to kludge our way through this. The yield to maturity is 10.96%.

The cost of equity is determined using the capital asset pricing model. CAPM for Cascade Water is as follows:

Rf + ?(Rm-Rf)

3.5 + (2.639)(12.52-3.5) = 27.3%

So the weighted average cost of capital for Cascade Water is:

(27.3)(.

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731) + (10.96)(.269)

19.95 + 2.95 = 22.9%

The next step is to determine what the net present value of the project is. First up, the tax credit that the project gives for the depreciation, which is going to be $1 million per year. This tax credit is a positive cash flow for the project, and is equal to the depreciation multiplied by the tax rate, which in this case is 34%. The tax credit only accrues if the company is profitable and therefore actually paying tax. We will assume this.

The choice of discount rate is also important. The pure play strategy implies that the company is evaluating the product strictly on its own, as opposed to against its normal risk characteristics. This is an interesting choice, given that the company already has a very high risk profile, with a beta of 2.6, which is higher than either of the pure play firms. Selling to children is probably riskier than adults, but also worth considering is that the company with multiple product lines is also likely to have better diversification. The pure play.....

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