Upsilon Ltd has the following (independent) investment opportunities: Outlay IRR
ID: 2733921 • Letter: U
Question
Upsilon Ltd has the following (independent) investment opportunities:
Outlay
IRR
Project A
$20,000,000
16%
Project B
$20,000,000
15%
Project C
$10,000,000
14%
Project D
$10,000,000
13%
Project E
$10,000,000
12%
The optimal capital structure calls for financing all projects with 60% ordinary equity and 40% debt. The most recent dividend (D0) was $0.60. The growth rate of earnings and dividends is 6% per year. The current price of shares is $6. The company has bonds that were issued with a coupon rate of 11% and a yield to maturity of 13%. The company’s dividend payout ratio is 25%, and it is in a 36% tax bracket. Upsilon Ltd earned $20 million last year after taxes.
Required:
(a) Calculate Upsilon Ltd.’s WACC.
(b) Which projects will Upsilon undertake? Why?
(c) What will Upsilon’s total capital budget be?
(d) Answer in words only:
(1) If you were senior management of the firm and Upsilon had only $4,000,000 for projects, what would the optimal capital budget be?
(2) If you were a divisional manager and all these projects were in your division and Upsilon had only $4,000,000 for projects, what would your response be?
Outlay
IRR
Project A
$20,000,000
16%
Project B
$20,000,000
15%
Project C
$10,000,000
14%
Project D
$10,000,000
13%
Project E
$10,000,000
12%
Explanation / Answer
Solution.
(a) Calculation of Upsilon Ltd.’s WACC.
Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate
= ( 0.60 x 1.06 / $6 ) +6%
= 6.10%
Cost of Debt = 11% x ( 1 - 0.36 )
= 7.04%
(b) Selection of projects.
Project A should be selected because theire IRR is highcompresion than other project.
Capital Cost Weight WACC Equity 6.10% 0.60 3.66 Debt 7.04% 0.40 2.82 WACC 6.48Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.