CEE_594_23 - CEE 594/Econs 494 Problem Set #2 (Due Wed....

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CEE 594/Econs 494 Problem Set #2 (Due Wed. October 11, in lecture) 1. As the financial Vice President of your company that is about to embark on a major new acquisition of an unrelated business, you have been asked to update your estimates of the company’s cost of capital for fine-tuning of the investment decision. Your company plans to continue it’s 80% equity, 20% debt financial structure, and your investment banker tells you your interest rate on new bonds should be 8% as compared to the 7% historical average. Other market and firm specific information is: Current market price of your stock =$27.00/share Current average return on a broad index of stocks =10% Current return on risk free government bonds =3% The anticipated dividend next year on your stock =$2.70/share Your company’s Beta =1.6 Your company’s projected dividend growth with the acquisition =4%/yr. a. Compute your company’s cost of capital and provide your recommendation of whether or not to proceed with the acquisition whose projected IROR is 13.5%, and explain why or why not. b. Discuss what other factors you would recommend that your company consider in determining whether or not to proceed with the acquisition. How would the fact that the riskiness of the business you are trying to acquire is considered to be greater than the market average and also of your current business affect your decision? 2. A company is confronted with the following real cash flows for two mutually exclusive investment opportunities: Year 1 2 3 4 Project A $ (80,000) $ 28,000 $ 28,000 $ 28,000 Project B $ (24,000) $ 9,800 $ 9,800 $ 9,800 a. Calculate the net present value of each of the above projects assuming your real cost of capital is 10%. b. Calculate the internal rate of return of each project. c.
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CEE_594_23 - CEE 594/Econs 494 Problem Set #2 (Due Wed....

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