Electric Scooter, Inc., staff has come up with the following estimates for the e

ID: 2722529 • Letter: E

Question

Electric Scooter, Inc., staff has come up with the following estimates for the electric scooter project:

Pessimistic Expected Optimistic

Market size 2.5 million 3.0 million 3.2 million

Market share 0.04 0.1 0.16

Unit price $300 $375 $400

Unit variable cost $350 $300 $275

Fixed cost $5 million $3 million $1 million

Conduct sensitivity analysis. What are the principal uncertainties in the project? Assume an initial investment of $16 million to be depreciated over a period of 10 years to a salvage value of zero. Corporate Tax rate is 34%. Assume a cost of capital of 10%.

Calculate the weighted average cost of capital for Carla Computer Company. The book value of Carla’s outstanding debt is $10 million. Currently, the debt is selling in the market at 110 percent of its book value and is priced to yield 12 percent. The one million outstanding shares of Carla’s stock are selling for $25 per share. The required rate of return on Carla stock is 20 percent. The tax rate is 34 percent.

Explanation / Answer

Answer

Answer 2

Market value of Debt = $10 million * 110%

= $ 11 million

Interest payment = Market value * Yield

= $ 11 million * 0.12

= $ 1.32 million

Cost of Debt before tax = Interest payment / Book value

= $ 1.32 million / $10 million

= 0.132

= 13.20 %

Cost of debt after tax = Cost of Debt before tax * (1 – tax rate)

= 13.20% (1 – 0.34)

= 13.20% (0.66)

= 0.08712

= 8.712%

Market value of Equity = Outstanding shares of Carla’s stock * Market price

= 1 million * $25 per share

= $ 25 million

Particulars

Market value ( in million)

Weight of Market value

Cost of Capital

Weighted cost of capital

A*B

Equity

0.6944

20.00%

13.89%

Debt

0.3056

8.712%

2.66%

1.0

Weighted Average Cost of capital

16.55%

Answer : The weighted average cost of capital for Carla Computer Company is 16.55%