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%

Burgundy is contemplating what for the company is an average-risk investment costing $40 million and promising an annual after-tax cash flow 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 shareholder? Why or why not?

Explanation / Answer

1) IRR:

 

Present value of perpertuity:

 

p=1/r

 

=1/0.048(CONSIDERED INTEREST RATE AS A DISCOUNT RATE)

 

IRR=20.83

 

2) WACC: wE*rE+wD*rD(1-Tc)

 

=071*0.14+0.29*0.048(1-0.035)

 

[since  equity 20 million *$40=800million : debt 320 million]

 

=0.0994+0.29*0.0312

 

=0.0994+0.0090

 

0.1084 percent

 

=10.84%

 

C) Yes ,it would be benefited to share holders because it gives higher IRR (20.83) than its WACC (10.84),The rest (margin) return can be appreciating the share holder value year to year.

 

 

 

 

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