You have the following information about Burgundy Basins, a sink manufacturer. E

Question

You have the following information about Burgundy Basins, a sink manufacturer.

Equity shares outstanding 20 million

Stock price per share $40.00

Yield to maturity on debt 7.5%

Book value of interest-bearing debt $320 million

Coupon interest rate on debt 4.8%

Market value of debt $290 million

Book value of equity $500 million

Cost of equity capital 14%

Tax rate 35%

8.) Burgundy is contemplating what for the company is an average-risk investment costing $40 million and promising an annual ATCF of $6.4 million in perpetuity. a. What is the internal rate of return on the investment? b. What is Burgundy’s weighted-average cost of capital? c. If undertaken, would you expect this investment to benefit share- holders? Why or why not?

Explanation / Answer

a. The internal rate of return on the investment= PV (10,9%)= $41.0752 million & PV (10,10%)= $39.328 million

so, IRR on the investment = 9% + (41.0752 -40 / 41.0752-39.328) (10%-9%)

= 9.62%

b. Burgundy’s weighted-average cost of capital=

WACC = E/V * Re + D/V *Rd * (1-Tc)

=> Market value of debt = $290 million

Market value of equity = 20 million * $40 = $800 million

So, WACC = 800/1090*0.14 + (290/1090 * 0.048) (1-0.35)

= 0.10275 + 0.00830 = 11.11%

c. The Burgundy's should not undertake the Investment project as it is not beneficial to the Equity Shareholders because the required Expected rate of return of equity is 14% whereas the IRR is 9.62% and which is well below the WACC of the company.

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