Especialistas de Vela Case

Pedro Garcia is a financial analyst with Especialistas de Vela, S.A., a Spanish manufacturer of sailboats. Garcia is evaluating a proposal for Especialistas de Vela to build sailboats for an Italian competitor that lacks production capacity and sells in a different market. The sailboat project is estimated to have about the same risk as Especialistas de Velas other projects. The proposal covers a limited time horizon of three yearsafter which the competitor expects to be housed in a new, larger production facility. The limited time horizon appeals to Especialistas de Vela, which currently has excess capacity, but expects to begin its own product expansion in slightly more than three years. Garcia has collected much of the information necessary to evaluate this proposal in Tables 1 and 2. Table 1 Selected Data for Sailboat Proposal (Currency amounts in millions) Initial fixed capital outlay Annual contracted revenues Annual operating costs Initial working capital outlay (recovered at end of the project) Annual depreciation expense (both book and tax accounting) Economic life of facility (years) Salvage (book) value of facility at end of project Expected market value of facility at end of project Table 2 Selected Data for Especialistas de Vela, S.A. Book value of long-term debt/total assets Book value of equity/total assets Market value of long-term debt/market value of Market value of equity/market value of company Coupon rate on existing long-term debt Interest rate on new long-term debt Cost of equity Marginal tax rate Maximum acceptable payback period

60 60 25 10 20 3 0 5

28.60% 71.40% 23.10% 76.90% 8.50% 8.00% 13.00% 35.00% 2 years

Garcia recognizes that Especialistas de Vela is presently financed at its target capital structure and expects that the capital structure will be maintained if the sailboat project is undertaken. Especialistas de Velas managers disagree, however, about the method that should be used to evaluate capital budgeting proposals.

One of Especialistas de Velas vice presidents asks Garcia the following questions: 1. The weighted average cost of capital for Especialistas de Vela is: A. 10.78%. B. 11.20%. C. 11.85%. D. 11.96%. 2. The total net cash flow ( millions) for the sailboat project in its terminal year is: A. 33.00. B. 39.75. C. 43.00. D. 44.75. 3. The IRR for the sailboat project is: A. 18.5%. B. 19.7%. C. 20.3%. D. 24.7%. 4. Will projects that meet a corporations payback criterion for acceptance necessarily have a positive net present value (NPV)?

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