Week 5 (Textbook Assignment 3) Time Value of Money (Chp 9) and Cost of Capital (

Question

Week 5 (Textbook Assignment 3) Time Value of Money (Chp 9) and Cost of Capital (Chp 11) Version A 1. Future Value and Annuity Payments Christy and Michael are trying to decide if they will have enough money to retire early in 15 years, at age 60. Their current assets are $250,000 in retirement plans and they have $80,000 in other investments. Together, they contribute $30,000 per year to their retirement plans and another $6,000 to other investments. a. If their assets grow at 9 percent per year, how much money will they have when they turn 60? b. After they retire, they will invest their wealth more conservatively and it will earn 6 percent per year. What will be the amount of their annual payments if they expect to live for 30 years in retirement? 2. Cost of Capital (WACC). Suppose your company has decided to use a divisional WACC approach to analyze projects. The firm currently has 2 divisions, A and B, with betas for each division of 0.5 and 1.5, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5%) is 14% and the after-tax yield on the company's bonds is 6%, what are the WACCs for divisions A and B? Hint: First Solve for Market Risk Premium (MRP). MRP = (Km-Rf) a. Division A WACC? b. Division B WACC?

Explanation / Answer

a) Total available amount in hand is $250,000 plus $80,000.

Total investment amount = $330,000

yearly amount invested by them is $30,000 plus another $6,000

Total payment = $36,000

Use the excel formula to find the future value.

FV = (Rate, Nper, PMT, PV)

     = (9%, 15, -36000, 330,000)

    = $145,026.23

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b) Compute the payment amount:

Use the excel formula to find the Payment:

PMT = (Nper, Rate, PV, FV)

        = (30, 6%, 145026.23, 0)

       = $10,536

Therefore, the annuity payment is $10,536

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2) WACC = (Weight of debt X Cost of debt) + (Weight of equitiy X Cost of equity)

                 = (0.5 X 0.06) + (0.5 X 0.14)

                 = 0.03 + 0.07

                 = 0.10 or 10.00%

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