Common Stock Valuation and Principles of project Feasibility:
Question 1. Common Stock Valuation
R= Dividend yield + Capital gains yield
Given that D1 =150; P0= 10000 and g = 12%
Question 2. Corporate Valuation
|Year||FCF||(1+WACC)t||Discounting value||Present value of FCF|
|Value of entire company||8,165.76|
Question 3. Weight Average Cost of Capital (WACC)
Whereby WD is the proportion of debt; RD is the cost of deb; TC is the tax rate; WP is the proportion of preferred stock; RP is the cost of preferred stock; WE is the proportion of common stock and RE is the cost of common stock (Gitman & Zutter, 2012)
Proportion of debt (WD) = 0.3
Proportion of preferred stock (WP) = 0.3
Proportion of common stock (WE) = 0.4
Cost of debt (RD) = 6.5% = 0.065
Cost of preferred stock (RP) = 8.5% = 0.085
Cost of common stock (RE) = 7.5% = 0.075
Tax rate 30% = 0.3
Question 4. Principles of project Feasibility
The objective of investing in capital projects in creating wealth for stakeholders. This means that engaging in any capital project is mainly for the reason of generating good returns.
The decision on whether to invest in a particular capital project requires carefully consideration given the large capital outlay that is required. Eddy Koehler’s aim to win a 15 year gold mining concession from the South Africa government means that generating a good return within this period is of paramount importance(Ross, Westerfield& Jordan, 2001).
The hope for Koehler is being able to reap favorable returns within the 15 year period by offering or sacrificing a huge amount of current resources. Therefore, effective appraisal of the project is highly important in determining its real value so as to avoid investing resources in a loss making entity (Broadbent & Cullen, 2012).
Therefore, the role of carrying out a study on the feasibility of a project is first to eliminate projects which are not good enough through an evaluation process(Ross, Westerfield& Jordan, 2001). Given that this project is a long-term undertaking, it’s important to put great effort in evaluating its benefits and costs before offering to put large sums of money into it. Even if a decision is made not to go ahead with it, there will be valuable information that would have been gained that can be carried forward and applied in other future projects.
Secondly is to ensure that projects that are deemed good are actually implemented and not discarded. This is because; justification is required to be given to the stakeholders of the project on the necessity of the project(Ross, Westerfield& Jordan, 2001).
Once the decision has been made to implement the project, it will be difficult in reversing it without suffering huge costs. This is because of there could already have been assets inform of equipment that would have been acquired as well workers hired. Therefore stopping the project would already have consumed some funds which cannot be recovered(Ross, Westerfield& Jordan, 2001). This makes the issue of ensuring effective project feasibility even more important. For example in the mining of gold, the investor will have to acquire machinery and build infrastructure necessary to access the mines. If after putting together the necessary infrastructure and being ready to mine and then decides to “bail out”, there will be huge losses in the form of redundant equipment as well the already build infrastructure that cannot find another productive use.
Another reason for a project feasibility study is to determine the potential sources of risk to the project and the level of these risks (Broadbent & Cullen, 2012). Finally, after determining the risks, the aim is to find ways of mitigating them. Given that it’s a new project for Koehler, the level of risk will be high given that the level of experience is low.
The project will have some externalities attached to it in the form effects on the surrounding environment. These include possible air pollution as well influencing the communities in form of offering jobs(Ross, Westerfield& Jordan, 2001).These are referred to as the “spill overs” which could either be positive or negative. Therefore, it’s important to ensure that the project takes into consideration that some of its cash flows could be “eroded” from negative activities (Gitman &Zutter, 2012). For example, possible new legislation could create costs in form of fines to the firm if it does not adhere to set limits.
Therefore, project feasibility will involve a number of stages that include planning, analysis, selection, implementation and review (Gitman & Zutter, 2012).
The planning process deals with a preliminary evaluation of the project.
The analysis process deals with assessing various aspects including economic, financial technical and an assessment of the market. The technical assessment is concerned with the determination of the level of technology required and their costs. Economic evaluation is concerned with assessing the benefits as well the costs associated with it in form of its effects to the society.
A market analysis is deals determining the level of demand as well the supply of products. This is to find out whether the project’s products will have a ready market and whether demand is adequate to guarantee favorable sales and therefore good returns.
Another important factor that the need to be undertaken is the evaluation of the level of working capital available. This means that the project will require ready cash to start in the acquisition of machinery and for labor costs (Ross, Westerfield& Jordan, 2001). Therefore, it’s important to ensure that the available capital is adequate to cover the initial costs so that the project does not come to halt midday its operations.
Finally, it’s important to assess the financing costs relevant to the project. This is through assessing the net present value (NPV) of the project (Ross, Westerfield& Jordan, 2001). The choice of using either debt or equity is basically a decision which is carried out by the management. However, the most important aspect is to determine whether in overall terms the project will be able to generate a positive net present value (Ross, Westerfield& Jordan, 2001).
Broadbent, M. & Cullen, J. (2012).Managing Financial Resources. New York:
Gitman, L, J, Zutter, C, J. (2012). Principles of Managerial Finance (13th Ed)
Ross, S, A, Westerfield, R, W, Jordan, B, D. (2001). Essentials of corporate finance.
Boston: McGraw-Hill Irwin