Essay on Finance
1) What are the appropriate costs of capital for the GPS transmitter and surveillance aircraft projects?
The cost of capital is used to discount the expected cash flow of a proposed project to its present value to make an evaluation of whether to proceed or drop out the project. Normally, a company cost of capital or WACC is used as the discount rate for projects. However, as WACC represents the average rate of return demanded by investors in the company's debt and equity securities, it is only a suitable discount rate for projects that have same risk as the company's existing business. Some companies use the WACC as a starting point or benchmark then add or subtract for riskier or …show more content…
In excel, we first obtain the monthly returns for Sky Hawk and the index and we are left with 59 observations each. To find the beta, it is the slope of the regression which can be obtained by running a regression analysis, plotting a scatter plot or using the slope function in excel.
The equity beta is equal to 1.3872, as expected to be lower than the GPS transmitter project by Rogers.
Applying the same formula: βA = (D/D+E)* βD + (E/D+E)* βE βE = 1.3872 βA = (E/D+E)* βE = 0.6 * 1.3872 = 0.83232
Rproject = rf + βA (rm - rf) rf = 4% (Government spot rate) = 0.04 + 0.83232 (0.05) rm - rf = 5% (market risk premium from case) Rproject = 0.081616
It is HMT's policy to add issuance cost to the cost of capital which is 5%.
As such, the appropriate cost of capital for the Surveillance Aircraft project is 0.081616 + 0.05 = 0.131616 = 13.1616%
2) What are the NPV of the two projects?
The NPV for the GPS Transmitter project is -$3131302 which means the project would suffer a loss.
The $2.5m paid to Abby Hu and the $350,000 working capital is the capital expenditure HMT has to make in year 0 to kick start the project. There is no salvage value for the patent and software, but the working capital can be liquidated at the