Question

Suppose Amazon has decided to introduce the Echo III.   Before they launch the Echo III, they...

Suppose Amazon has decided to introduce the Echo III.   Before they launch the Echo III, they conducted an analysis to see if the Echo II would be a desirable investment. The company estimated that it would sell 10 million Echo IIIs per year at a price of $250 for the next six years.

The initial capital outlay is determined to be $1.25 billion and a $600 million outlay in net working capital would also be required.

Assume that the equipment used will be depreciated using the MACRS 7 year schedule and that the equipment has a salvage value of zero. At the end of year 6, the equipment will be sold for its book value. Also, assume that that the tax rate is 25%.

5. Use the 10 year Treasury Bond rate as the risk free rate and assume that the market risk premium is 7% to find Amazon’s cost of equity. Assume that Amazon’s bonds are rated AAA and that Amazon’s corporate tax rate is 25%. Find Amazon’s weighted average cost of capital. Assume that the project will be financed with internal funds. You will need to find additional financial information from the Wall Street Journal and online at sites like http://finance.yahoo.com to complete your calculation.

6. Using your cost of capital estimates in part 5, recalculate the original NPV and IRR using these new estimates. (Redo part 2, but use the number you estimated instead of 12%). (part 2: If the cost of capital is 12%, compute the NPV and IRR for the project. Test the sensitivity of NPV to changes in the cost of capital by increasing the WACC by 1%.)

7. Write up your findings and determine if Amazon should produce the Echo III. You do not need to submit a spreadsheet for every calculation. Just summarize your results in a table and submit one spreadsheet. Given your analysis, should Amazon proceed with the Echo III?

please show all work/ formulas in excel*****!!!!

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Answer #1

Question 5:

Amazon's WACC calculation

Debt value from balance sheet =24.743 Billion

Equity market value=697.84 Billion

Total =722.583 Billion

Weight of equity = 697.84/722.583 = 0.9657

Weight of debt = 1-0.9657 =0.0343

After tax Cost of debt = 4.25%*(1-0.25) = 3.1875%

Cost of equity = rf + beta*risk premium = 2.85+1.72*7 = 14.84%

WACC = 0.9657*14.84% +0.0343*3.1875% = 14.44%

WACC of Amazon =14.44%

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