Question 1:
(Cost of Capital)
8 points
You are provided the following information on a company. The total market value is $40
million. The company’s capital structure, shown here, is considered to be optimal.
Market Value
Bonds, $1000 par, 6% coupon, 4% YTM
$10,000,000
Preferred Stock, 3%, $100 par, 100,000 shares @ $70 per share
$7,000,000
Common Stock, 100,000 shares @ $230 per share
$23,000,000
a.
What is the after-tax cost of debt?
(assume the company’s effective tax rate = 40%)
b.
Assuming a $3 dividend paid annually, what is the required return for preferred shareholders
(i.e. component cost of preferred stock)?
(assume floatation costs = $0.00)
c.
Assuming the risk-free rate is 1%, the expected return on the stock market is 7%, and the
company's beta is 1.1, what is the required return for common stockholders (i.e., component cost
of common stock)?
d.
What is the company's weighted average cost of capital (WACC)?
Question 2:
(Capital Budgeting)
10 points
It's time to decide how to use the money your firm is expected to make this year.
Two
investment opportunities are available, with net cash flows as follows:
Year
Project X
Project Y
0 (Now)
($30,000)
($30,000)
1
11,000
4,000
2
10,000
8,000
3
9,000
12,000
4
8,000
16,000
a.
Calculate each project's Net Present Value (NPV), assuming your firm's weighted average
cost of capital (WACC) is 6%
b.
Calculate each project’s Internal rate of Return (IRR).
c.
Plot NPV profiles for both projects on a graph.
d.
Assuming that your firm's WACC is 6%:
(1) If the projects are independent which one(s) should be accepted?
(2) If the projects are mutually exclusive which one(s) should be accepted?
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