Exercise #1: Regal Industries has the following capital structure. Its corporate
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Question
Exercise #1: Regal Industries has the following capital structure. Its corporate tax rate is 35%. Security Book Value Market Value Weight Cost Debt $18 million $20 million 6% Common stock $27 million SO million 14% A. Compute WACC = B. Regal is evaluating a project costing $48,000 which will generate $10,000 for 6 years. It will require an increase of $2,000 in NWC at the outset, but no recapture. Should Regal accept the project? NPV = $ Accept? Exercise #2: Thrifty Inc. has $6,000,000 in long-term debt. The interest rate is 8%; the tax rate is 40%. The PV of the debt tax shield is $Explanation / Answer
(A)
debt's weight = 20/(20+50) = 2/7
common stock's weight = 50/(20+50) = 5/7
WACC = 6%*(1-35%)*2/7 + 14%*5/7 = 11.11%
(B)
NPV = - 48,000 - 2,000 + 10,000*PVIFA(11.11%,6) = - 48,000 - 2,000 + 10,000*(1-(1+11.11%)^(-6))/11.11% = - 7,828.34
As the NPV of the project, Regal should NOT accept it.
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PV of the debt tax shield = 6,000,000*8%*40% = 192,000
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