can someone help to solve this problem? 2-The capital structure of a company con

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can someone help to solve this problem?

2-The capital structure of a company consists of debt, common equity, and preferred stock. The firm has 10 million shares of common stock outstanding, 500,000 shares of preferred stock outstanding, and 200,000 bonds outstanding with $1,000 par value each. The common stock currently trades for $50 per share and has a beta of 1.80, the preferred stock pays annual dividend of $10 per share in perpetuity and currently sells for $100 per share, and the bonds are currently sell for 110 percent of par. The market risk premium is 6 percent, Treasury bills are yielding 4 percent, and the firm’s tax rate is 35 percent. The before-tax cost of debt is 8 percent.

      a)   What is the firm’s weighted average cost of capital (WACC or RWACC)?

      b)   The firm is evaluating a new 5-year investment project that has the same risk as the                                   firm’s typical project. The project requires an initial investment of $20 million. It is                              expected to generate annual after-tax cash flows of $8 million for 5 years. The project                         has no net working capital requirement and no salvage value. Find the net present value                            (NPV) of the project.

Explanation / Answer

Calculation of costs

Cost of equity = Risk free retuen + Beta ( Market risk premium)

= 4% +1.80(6)

= 4% + 10.80 i.e 14.80%

Cost of preference shares = Preference dividend ( 1-Tax ) / Preference share value

= 10(1-0.35)/100 i.e 6.5%

Cost of debt = 8% ( 1- Tax rate ) i.e 5.20%

WACC = Weight of equity * Cost of equity+ Weight of preferred stock * Cost of preferred stock + Weight of debt * Cost of debt

= 0.65*14.80+0.06*6.5+0.29*5.20

= 11.52%

2) Net present value = Present value of cash inflows - Present value of cash outflows

= 8000000*PVAF ( 11.52%,5 years) -20000000

= 8000000*3.648 -20000000

= 29184000-20000000 i.e 9184000

Depreciation has been ignored

Particulars Numbers Price Total Weights Common stock         100,00,000 50         5000,00,000 65% Preferred stock 500000 100           500,00,000 6% Debt 200000 1100         2200,00,000 29%         7700,00,000

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