Corporate Finance

Professor Ashok Thampy

Case Study: Finding WACC for a Project

The firm, Bolta Ltd, manufactures high precision specialized nuts and bolts that are customized for the
needs of specific applications. It has received an enquiry from the Spaceways Company to supply high
precision bolts that are needed for their new spacecraft designed to take passengers for a flight over
the earth to the limit of earth’s atmosphere of 100 kms and back, hopefully alive and safe. Special
bolts are needed that will not be affected by the temperature difference as the spacecraft goes up to
the outer atmosphere and on its decent back to the ground.

It is expected that the requirements will be about 3 million units in year 1, which will increase by 15%
for 2 years up to year 3, and then decrease by 15% for another 2 years.

Current plans foresee demand for these specialized nuts for only 5 years.

The price per bolt in year 1 is expected to be $ 50 which will increase by 8% each year to account for
inflation.

Variable cost is 50% of sales. Fixed cost is $ 6 million in year 1 which will increase by the inflation rate
of 8% each year.

In order to develop these new bolts, Bolta will have to upfront invest $ 20 million in research and
development. Also capital expenditure on plant and machinery for the new project is expected to be
$ 150 million. Both the research and development costs and the investment in plant and machinery
will have to be done one year before commercial production.

At the end of 5 years, the plant and machinery can be sold and it is expected that the salvage value
after tax is $ 30 million.

The capital investment is depreciated equally over the 5 year life of the project.

Working capital requirement is estimated to be 20% of sales and needs to be made in the previous
year, i.e., working capital required for sales in year t has to be made in year t-1.

Further, the firm plans to fund this project with a mix of debt and equity in the total capital in the
proportion of 40% debt and 60% equity.

Cost of debt is 10% and cost of equity is estimated to be 30%.

The corporate tax rate is 30%. This is obtained from the cost of equity of other firms that are suppliers
to firms like Spaceways.

We will estimate the Weighted Average Cost of Capital for Bolta.

© All Rights Reserved. This document has been authored by Professor Ashok Thampy and is permitted for use only within the course "Corporate
Finance" delivered in the online course format by IIM Bangalore. No part of this document, including any logo, data, illustrations, pictures, scripts,
may be reproduced, or stored in a retrieval system or transmitted in any firms or by any means – electronic, mechanical, photocopying, recording
or otherwise – without the prior permission of the author.