Zhejiang University Finance Exam Practice
UberZ Co is considering whether it should expand its self-driving cars division, or completely shut it down. To make this decision, the company paid McLindsay Co., a large consulting company, a fee of $20 million to evaluate the program. McLindsay reported the following information about that the self-driving expansion project: Five year project, with an initial investment at the beginning of the project of $100 million. This intial investment will be fully depreciated with no salvage value. There is no market for the used equiptment at the end of the project. Additional sales revenue generated by the expansion is expected to be $50 million a year. Operating costs are 50% of expected sales revenue. There are no effects on working capital. You are an assistant to the CFO of the company and your first task is to advise UberZ whether the company should do the expansion or not. The CFO has provided you with the following data, which he believes may be relevant to your task (all the market data are current). The firm’s tax rate is 20%. The market data on UberZ’s securities is:
Debt (two types of bonds)
Bond A: 35,000 bonds outstanding, 6.5% coupon (semi-annual) with 20 years to maturity, selling at 90% of par. Assume the par value is $1,000.
Bond B: 6,000 bonds outstanding, 5% coupon (semi-annual) with 15 years to maturity selling at par. Assume the par value is $1,000.
1,500,000 outstanding shares, selling for $50 per share;
Dividend (just paid) is $0.5 per share and is expected to increase its future dividends at a constant rate of 6%.
Assume the project’s riskiness is the same as the firm overall. The firm’s beta is 1.2.
Assume the risk-free rate is 1% and the market return is 10%.
Answer the following questions. Show your calculations and formulas for partial credit. DO NOT email pictures or screenshots of your work for partial credit, they do not count.
a. After taking into account for *all relevant* expenses, calculate cash flow from the assets (CFFA) for every year. (3 points)
b. Find UberZ’s capital structure weights. (4 points)
c. Find UberZ’s cost of equity using the capital asset pricing model (CAPM). (4 points)
d. Find UberZ’s cost of equity using the dividend growth model (DGM). (4 points)
e. Find UberZ’s cost of debt. (4 points)
f. What is UberZ’s weighted average cost of capital? (for the cost of equity use the average of values from CAPM and DGM.) (4 points)
g. Compute the NPV and the IRR of the project. (4 points)
h. Should the firm undertake the expansion project or not? Why? (1 points)