Chapter13 Problems

# Chapter13 Problems - Cost of Capital Problems MGMT 505...

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MGMT 505 Murali Jagannathan Cost of Capital Problems

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MGMT 505 Modified Problem 12.1 Furniture Depot has a beta of 0.95, D/E ratio of 50%, and a tax rate of 40% Market risk premium is 9% and r f =5% Yield to maturity of company’s debt is 8%. Company is considering a project that is expected to generate \$340,000 after-tax cash-flows each year for five years. Investment required is \$1.2m. If project is of similar risk to the firm and is financed with the same D/E, should the firm undertake the project?
MGMT 505 No difference in project risk, no difference in financial risk. So, we can use the firm’s current beta to compute cost of equity. Cost of Equity, k s = r f + β (r m - r f ) = 5 + 0.95 x 9 = 13.55% After tax cost of Debt = 8% (1-0.4) = 4.8% D/E=0.5 D/(D+E) =1/3 rd . WACC=1/3 x 4.8% + 2/3 x 13.55% = 10.63% CF0= -1.2m, CF01= 0.34m, F01=5, I=10.63%, NPV=?

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MGMT 505 Modified Problem 12.14 First data Co. has 20m shares outstanding that trade at \$25 a share. Firm’s debt trades at 95% of its 180m face value. The
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Chapter13 Problems - Cost of Capital Problems MGMT 505...

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