BGIA Inc. has a beta of 1.2, the current market return is 8% and the risk free i

Question

BGIA Inc. has a beta of 1.2, the current market return is 8% and the risk free is 3%. The company has 6 million bonds that currently sell at 102% of par, with a coupon rate of 5% and a maturity date of 20 years. The last dividend paid was $3 with a growth rate of 2%. The company also issued 5 million shares of common stocks that are currently priced at $50. BGIA Inc. has no preferred stocks. The company plans to build a new facility for which the cashflows are anticipated as follows: an initial investment of 950,000, and revenues expected to be 150,000 the first year, 300,000 for the second year, 250,000 for the third year, and 400,000 for the final year. You are hired to help the company make a decision to build the new facility. The corporate tax rate is 40% and the company's average payback for similar projects is 3 years. Find NPV, IRR, MIRR, and the payback periods.

Explanation / Answer

Step 1:

1) As per CAPM

Cost of Common Stock = Rf + (Rm-Rf)*Beta

Cost of Common Stock = 3 + (8-3)*1.2

Cost of Common Stock = 9%

As per Dividend Discount Model

Cost of Common Stock = D1/share Price + growth rate

Cost of Common Stock = 3*1.02/50 + 2%

Cost of Common Stock = 8.12%

Most realistic is dividend discount model

2) Before Tax Cost of Debt = rate(nper,pmt,pv,fv) *2

Before Tax Cost of Debt = rate(40,25,-1020,1000) * 2

Before Tax Cost of Debt = 4.84 %

After Tax Cost of Debt = Before Tax Cost of Debt *(1-tax rate)

After Tax Cost of Debt = 4.84*(1-40%)

After Tax Cost of Debt = 2.904%

Step 2:

Market Value of Common Stock = 5Milion * 50 = $ 250 Million

Market Value of Bond = 6 Million * 1020 = $ 6120 Million

Total Market Value = $ 6370 Million

Weight of Common Stock = 250/6370

Weight of Debt = 6120/6370

Step3:

WACC = Weight of Common Stock* Cost of Common Stock + Weight of Debt* After Tax cost of Debt

WACC = 250/6370*8.12 + 6120/6370*2.904

WACC = 3.1087%

NPV = -950000 + 150000/(1+3.1087%) +  300000/(1+3.1087%) ^2+  250000/(1+3.1087%) ^3 +  400000/(1+3.1087%) ^4

NPV= $ 59,621.52

IRR ,at wich NPV = 0

0 = -950000 + 150000/(1+r) +  300000/(1+r) ^2+  250000/(1+r) ^3 +  400000/(1+r) ^4

By Solving above equation using test trial run error method

we get

IRR = 5.40%

MIRR = (FV of Cash Inflow / PV of Cash outflow)^(1/n) -1

FV of Cash Inflow = 150000*(1+3.1087%)^3 +  300000*(1+3.1087%) ^2+  250000*(1+3.1087%) ^1 +  400000

FV of Cash Inflow = $ 1,141,142.41

PV of Cash outflow = 950000

MIRR = (1141142.41/950000)^(1/4) -1

MIRR = 4.69%

Payback periods = 3 + 250000/400000

Payback periods = 3.625 Years

Year Cash flow Cummulative Cash Flow 0 -950000 -950000 1 150000 -800000 2 300000 -500000 3 250000 -250000 4 400000 150000

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