The company faces two choices that Mr. Smith must evaluate with your assistance: continue with the current smaller sized stores, or select larger stores for the firm’s strategic growth or construction plan. The initial cost will be $2,100,000 for each of the smaller sized stores and $3,700,000 for each of the five larger ones. Projected present value of cash flows for the smaller units projected for the firm’s five-year strategic plans are $450,000 for each year while the projected cash flows for the larger units are projected to be $740,000 per year. Because the projects must be financed from different sources, unfortunately, financing costs will be different. Mr. Smith’s data indicates that the current and projected 120-day treasury bill rate is 9.75% and the firm’s expected market return is 12.5% for the plan period. The beta for the African art industry and the planned new stores is 1.15. However, the bond rates for the projects are 10% for the smaller stores and 12.7% for the larger store funds. Thus, the details have been provided for the analysts, namely you, to:
1. Determine the capital asset pricing model rate for the firm.
2. Combine that rate with the specific debt rates for each store model, using a tax rate of 34%.
3. Determine the weighted average cost of capital (WACC) for each project.
4. Find the net present value (NPV) for each alternative purchase.
5. Use the NPV and profitability index analyses (because each project will have a different WACC rate) to advise/convince Mr. Smith of your selection of the most desired, profitable project for the company.