Comprehensive Case Study

Nova Corp.

If Damon Nova Corporation asks its financial manger to measure the weighted average cost of
capital based on the historical raised capital which is as follows: 35% Long term debt, 12%
preferred stocks and 53% common Stock equity. The needed financial information and data as
follows:
Should Damon Nova accept this proposal based on NPV technique?
 Solution
Initial investment:
Installed cost of new asset =
Cost of new asset
+ Installation costs

Total cost of new asset $160,000

- After-tax proceeds from sale of old asset
Proceeds from sale of old asset 70,000
− Tax on sale of old asset* (7,497)
Total proceeds from sale of old asset (62,503)
+ Change in working capital 18,000

Initial investment $115,497

*
Accumulated Depreciation = 120,000 x 71% = 85,200
Book value of old asset: 120,000 – 85,200= 34,300. So, $70,000 − $34,300 = $35,700 gain on sale of
asset. Hence, the total tax of sale of asset is $7,497.

Calculation of Operating Cash Flows

Profits before Operating
Depreciation Net Profits Net Profits Cash
Year and Taxes Depreciation before Taxes Taxes after Taxes flows
Old Machine
1 $95,000 $14,400 $80,600 $16,926 $63,674 $78,074
2 $95,000 $14,400 $80,600 $16,926 $63,674 $78,074
3 $95,000 $6,000 $89,000 $18,690 $70,310 $76,310
4 $95,000 0 $95,000 $19,950 $75,050 $75,050
5 $95,000 0 $95,000 $19,950 $75,050 $75,050
New Line
1 $105,000 32,000 $73,000 $15,330 $57,607 $89,607
2 $115,000 51,200 $58,800 12,348 46,452 97,652
3 $120,000 30,400 $89,600 18,816 70,784 101,184
4 $120,000 19,200 $100,800 21,168 79,532 98,332
5 $120,000 19,200 $100,800 21,168 79,532 98,332

Calculation of Incremental Cash Flows

Year New Line Existing Line Incremental Operating Cash Flow
1 $89,607 97,652 $11,533
2 97,652 101,184 19,584
3 101,184 98,332 23,110
4 98,332 98,332 23,282
5 98,332 97,652 23,282
 Terminal cash flow:
After-tax proceeds from sale of new asset =
Proceeds from sale of new asset $24,000
−Tax on sale of new asset* (3,360)
Total proceeds from sale of new asset 20,640

- After-tax proceeds from sale of old asset

Proceeds from sale of old asset 8,000
− Tax on sale of old asset* (1,680)
Total proceeds from sale of old asset (6,320)
+ Change in working capital 18,000

Terminal cash flow $32,320

Before tax cost of debt = 7.04%

After tax cost of debt = 5.56%
Cost of preferred Stock = 6.12%
Cost of retained earnings = 14.29%
Cost of new issuance = 14.8%
WACC = 10.25% (using retained earnings)
WACC = 10.52% (using new issuance)

NPV =