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?
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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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