1) S. Systems Inc. pays a $6 current dividend (D0=$6), the dividend is expected
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Question
1) S. Systems Inc. pays a $6 current dividend (D0=$6), the dividend is expected to grow at a constant rate of 8% a year, and the common stock currently sells for $45 per share. the before tax cost of debt is 12% and the tax rate is 40%. The target capital structure consists of 50% debt and 50% common equity. What is the company`s WACC if all the equity used is from retained earnings?
2) Cornell Systems analyzed the project whose cash flows are shown below. It is 100% debt financed. The tax rate is 20%. The yield on company`s bond is 6,25% Year 0 1 2 3 Cash flows -$950 $500 $400 $300 Calculate the projects NPV, Profitability ratio and decide whether you accept it or not. If the payback period acceptable for a company in 2.5 years, would you accept a project, being based on discounted cash flows?
3) Is it true? Explain! If our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.
Explanation / Answer
1) S. Systems Inc. pays a $6 current dividend (D0=$6), the dividend is expected to grow at a constant rate of 8% a year, and the common stock currently sells for $45 per share. the before tax cost of debt is 12% and the tax rate is 40%. The target capital structure consists of 50% debt and 50% common equity. What is the company`s WACC if all the equity used is from retained earnings?
Cost of Equity (retained Earning) = D0*(1+g)/Share Price + g
Cost of Equity (retained Earning) = 6*(1+8%)/45 + 8%
Cost of Equity (retained Earning) = 22.40%
WACC = Weight of Equity* Cost of Equity + Weight of Debt* After Tax cost of Debt
WACC = 50%*22.4 + 50%*12*(1-40%)
WACC = 14.80%
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