Imagine that you own a company, Optimus, Inc., which is funded with 40% debt and 60% common stock; there is no preferred stock in the capital structure. The debt has an after-tax cost of 4%. You have studied the Electrobicycle project, and you believe that the auto company who has done the research and development (R&D) has made a crucial mistake. You believe that after the first 5 years, there will be worldwide expansion opportunities and many more years of revenues and earnings from selling Electrobicycles. Thus, you would not shut down the project in Year 5. Instead, you believe you will be able to sell the Electrobicycle business in Year 5 to a multinational company that will continue to produce the products and sell them internationally for many years into the future. You believe the sale of the Electrobicycle business in Year 5 will be for at least $15.0 million. Thus, you believe the value of the Electrobicycle project is significantly higher than the auto company realizes.
For the initial post,
- Calculate Optimus’ required rate of return on equity using the capital asset pricing model (CAPM). For the CAPM, use the following assumptions:
- Use a risk-free rate of 4.0%.
- Use 6.0% as the market risk premium.
- For the beta, use the beta below, according to the first letter of your first name
First Letter of First NameBetaA through B0.30C through D0.40E through F0.50G through H0.60I through J0.70K through L0.80M through N0.90O through P1.00Q through R1.10S through T1.20U through V1.30W through Z1.40
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- Calculate the WACC for Optimus. As a reminder, Optimus is funded with 40% debt and 60% common stock; there is no preferred stock in the capital structure. The debt has an after-tax cost of 4%.
- Use the Optimus required rate of return on equity that you calculated using the CAPM.
- Explain why it is appropriate for Optimus to value the Electrobicycle project using its WACC. Compare using the WACC to using solely the cost of equity in valuing the Electrobicycle project.
Guided Response: Review several of your colleagues’ posts, and reply to at least two of your peers by 11:59 p.m. on Day 7 of the week. You must respond to two classmates who have completed different calculations than you. In your written responses to your classmates, do the following:
- Confirm the calculations, or explain a correction to the calculation in the initial post.
- Compare how your calculated WACC is different than your classmate’s calculated WACC.
- Explain how the different WACCs would impact the net present value of the Electrobicycle project.
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