Introduction to Capital Budgeting

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Colorado Technical University **We aren't endorsed by this school
Course
ACCT ACCT614-11
Subject
Finance
Date
Oct 19, 2023
Pages
6
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Introduction to Capital Budgeting/Investment Valuation Cameron Washington Colorado Technical University August 9, 2023
In looking at how Apix Printing wants to expand its business to the label printing market it has decided to look for outside investment capital in order to facilitate the needed resources to make this move. When looking into a new project that is in need of financing the capital structure of Apix Printing needs to be assessed. The capital structure is amount of equity and debt that a company uses in order to fund its operations and assets. (corporatefinanceinstitute.com, 2019). In order to properly assess whether or not the project is viable to the company's shareholders and will enhance their wealth when the debt to equity ratio shifts further towards debt. As that debt to equity ratio shifts more towards debt, the shareholder's will be concerned with the amount of wealth that will be sacrificed in order to maintain a healthy level. In order to first determine the needs of the shareholder is in the upcoming capital project. We must first determine the WACC (weighted average cost of capital) of Apix printing. Previously shared numbers of the debt, equity, rates and beta are as follows: Weights of 40% debt and 60% common equity (no preferred equity) A 35% tax rate Cost of debt is 8% Beta of the company is 1.5 Risk-free rate is 2% Return on the market is 11% In order to calculate the WACC from the above data set, we must first ascertain the cost of debt and the cost of equity for Apix. The cost of debt was previously provided at 8%. In
order to calculate the cost of equity using the remaining data we must use the following formula. Cost of equity = risk-free interest rate + beta (market rate - risk-free rate) With the risk-free rate of 2%, beta of 1.5, and market rate of 11% we can see the following solution to the formula 2 + 1.5(11 - 2) Giving us the cost of equity at 15.5%. Now that we have a cost of debt at 8% and cost of equity at 15.5% we must factor in the company's current debt and equity (.4 x 8) + (.6 x 15.5) This will lead us to a WACC of 12.5% As mentioned earlier that the investors of the company will view the WACC as a means of evaluating the amount of return on equity to determine whether or not an investment towards Apix's future would prove to be beneficial to them. In the above WACC the stockholders would need a return on equity of 19.79% in order to see the investment as favorable. We can see this calculation here: ROE = return on assets + (return on assets - return on debt) debt / equity 19.79% = 15.5 + (15.5 - 8).57 As the equity to debt ratio changes, so will the required return on equity that the shareholders will need in order to feel that investing in Apix's new venture is worthwhile to them. Investors will also be interested to see what the marginal cost of capital is when investing in a large project. The marginal cost of capital is the required rate of return on any
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