A company has a beta of 1.5. The market risk premium is 8%. The risk free rate i
ID: 2718964 • Letter: A
Question
A company has a beta of 1.5. The market risk premium is 8%. The risk free rate is 6%. The tax rate is 40%. This company can borrow at a 10% interest rate. The D/E ratio is 1. This company is considering two mutually exclusive projects with the following net cash flows.
What is the WACC of this company?
Calculate the NPV, IRR, MIRR? (Hint: Consider both projects end in Year 7.)
Based on the answers to parts a and b, which project should be accepted?
Assume that the WACC is changed to 18%, which project should be accepted?
Year 0 1 2 3 4 5 6 7 Project A -300 -387 -193 -100 600 600 850 -180 Project B -405 134 134 134 134 134 134 0Explanation / Answer
Risk free rate 6% Risk premium 8% beta 1.5 So, expected rate of return = 6% + 1.5 x 8% = 18% WACC = {10% x (1-40%) + 18%}/(1+1) =12% Present Value using discount rate of:- cashflows pv factor Present Value 18% 18.10% 19.00% 20.00% 21.00% 22.00% 23.00% 23.97% 24.00% Year Project A Project B at 18% Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B Project A Project B 0 -300 -405 1 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 -300 -405 1 -387 134 0.847458 -327.966 113.5593 -327.966 113.5593 -327.697 113.4662 -325.21 112.605 -322.5 111.6667 -319.835 110.7438 -317.213 109.8361 -314.634 108.9431 -312.165 108.0881 -312.097 108.0645 2 -193 134 0.718184 -138.61 96.23671 -138.61 96.23671 -138.382 96.07901 -136.29 94.62609 -134.028 93.05556 -131.822 91.5238 -129.669 90.02956 -127.57 88.57162 -125.575 87.18677 -125.52 87.1488 3 -100 134 0.608631 -60.8631 81.55654 -60.8631 81.55654 -60.7135 81.35615 -59.3416 79.51772 -57.8704 77.5463 -56.4474 75.63951 -55.0707 73.79472 -53.7384 72.00945 -52.483 70.32722 -52.4487 70.28129 4 600 134 0.515789 309.4733 69.11571 309.4733 69.11571 308.4599 68.88938 299.2013 66.82161 289.3519 64.62191 279.9044 62.51199 270.8395 60.48748 262.1385 58.54426 254.0053 56.72785 253.7842 56.67846 5 600 134 0.437109 262.2655 58.57263 262.2655 58.57263 261.1924 58.33298 251.4296 56.15262 241.1265 53.85159 231.326 51.6628 221.9996 49.5799 213.1207 47.59696 204.8876 45.75823 204.6646 45.70844 6 850 134 0.370432 314.8668 49.63783 314.8668 49.63783 313.3215 49.39421 299.321 47.18707 284.6633 44.87633 270.8362 42.69653 257.7864 40.63926 245.4643 38.69672 234.1296 36.90984 233.8239 36.86164 7 -180 0 0.313925 -56.5065 0 -56.5065 0 -56.1831 0 -53.2652 0 -50.2347 0 -47.3996 0 -44.7459 0 -42.2607 0 -39.9929 0 -39.932 0 Total 2.660373 63.67874 2.660373 63.67874 0.00 62.51797 -24.1548 51.91015 -49.4912 40.61836 -73.4367 29.77843 -96.0738 19.36699 -117.479 9.362097 -137.193 0.00 -137.725 -0.25685 Discount Rate 18% cashflows PV of cash outflows FV of Cash inflows Year Project A Project B Project A Project B Project A Project B 0 -300 -405 -300 -405 1 -387 134 -327.966 158.12 2 -193 134 -138.61 186.5816 3 -100 134 -60.8631 220.1663 4 600 134 1163.27 259.7962 5 600 134 1372.65 306.5595 6 850 134 2294.62 361.7403 7 -180 0 -56.5065 0 Total -883.945 -405 4830.542 1492.964 MIRR 27.46% 20.49% MIRR = (future value/Present Value)^(1/7) NPV IRR MIRR Project A 2.660373 18.10% 27.46% Project B 63.67874 23.97% 20.49% Project A should be accepted
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