Case Study 5

UMUC

20 April 2021

Introduction
Tortuga began with a modest amount of capital that the founder had managed to save during his

years in academia. As the firm grew, its financing needs expanded as well. Through the years

Tortuga had developed and maintained a strong relationship with a large bank which provided

short-term working capital funds in the form of a revolving line of credit. When a funding need

arose, Tortuga would draw from this line of credit and then repay the short-term draw as cash

flowed back to Tortuga. The $200 million revolving line of credit currently has $25 million

drawn at an interest rate of 3-month Libor plus 350 basis points2. The remaining $175 million

credit line can be assumed to have no fees associated with it3. Brooks looks up the most recent

3- month U.S. dollar Libor rate and sees that it is 1.50%.

Using the Capital Asset Pricing Model, what is the required rate of return on equity, ke

(cost of equity) for Tortuga?

We would take the cost of equity formula Rf+(Rm-Rf)*Beta. 4%+(6%)*1=10%

Rf = 4% (Given) B(P) = Beta * Market Risk Premium = 0.06433 Beta = 1.0722 (Using Returns

on Tortuga Stock versus the Standard & Poor 500 table)Market Risk Premium = 6% (Given) ke

is 10.43%

Analyzing the company’s bond, what is the yield to maturity on the bond issue, kd (cost

of debt)?

kd = cost of debt using yield to maturity and current values for short-term
NPER = 8*2 8
PMT= 1000*8.5% 85
PV= 1000*2.5% -1025
FV= 1000
Rate =Rate(NPER,PMT.PV,FV)
Rate 8.06%

Cost of debt after tax 8.06%*(1-34%)=

The total amount for Tortuga cost of debt after tax will be 5.32%.
 Using the market weight of equity, the original issue amount of debt, and the

outstanding portion of the revolving line of credit, what are the weights of equity and debt in

the capital structure (we & wd)?

We = Market Value of Total Debt / (Market Value of Total Debt + Market Value of Equity) =

(50,000,000 * 102.50%) / (51,250,000 + 80,000,000) = 39.05%

Wd = Market Value of Equity / (Market Value of Total Debt + Market Value of Equity) =

(50,000,000/10 * $16) / (51,250,000 + 80,000,000) = 60.95%

Using the information provided, what is the firm's weighted average cost of capital

(WACC, ka)?

WACC = Cost of equity*Market value of equity + Cost of revolving credit*cost of

credit*(1-tax rate) + cost of bonds*cost of bonds*(1-tax rate)/(Market value of equity + market

value of revolving credit + market of bonds).

(10%*80+(5%*(1-34%))+(51.25*5.32%))/(100)= 10.76%

What are the net present value (NPV), internal rate of return (IRR), and Payback Periods
Y
for Projects A & B? Project A Project B
ear
1 -900 950
2 200 950
3 900 950
4 1800 950
5 2500 950
6 2500 950
7 1800 950
8 1200 950
9 800 950
NPV=1,634.16 NPV=1,219.47
10 200 950
IRR=13.68%
IRR=13.77%
Payback= 5.20 years Project A Payback=5.26 years Project B
What decision rules will you use to help Tortuga reach a decision?
 The companies NPV. IRR and payback period are the capital budgeting tool that helps to

determine the economic feasibility of the projects they are preforming. The above values of the

project have a higher positive return should be accepted. In this case project A has the higher

NPV, which is should be accepted. The IRR of any project that has return higher than the

weighted average of cost of capital, which is project B can be accepted as well. Payback period

in the project offering a return on investment earlier should acceptable as well. But in this case

project A has lesser payback period and should be accepted.

For strength and weakness of the techniques performed, the NPV is superior technique

because it assumes that each cash reinvested the company required rate of return or WACC.

Whereas the IRR assumes that each cash flow is so invested that it yields zero return. The

payback is also widely used tool but as compared to NPV, it is less commonly used. The

company should use the NPV as the benchmark for the decision making.

The company should select project A based on NPV. If we look at IRR and payback

period, then project B seems feasible. But NPV is superior tool therefore project A is more

feasible and therefor is should be undertaken.