A note to students on this problem. yes, it is a bit involved so think about wha
ID: 2743558 • Letter: A
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A note to students on this problem. yes, it is a bit involved so think about what information you will need to develop in order to answer the questions. Hint: You might want to take a look at Figure 12.4 on page 486. I do not expect you to send me a graph, but you might find figure 12.4 helpful in figuring out what you need to know. P-5. The Acme Chip Manufacturing Company (potato not computer) has a target capital structure of 40% debt and 60% common equity. They also have a 40% tax rate. They have three projects under consideration code named: Manny, Moe, and Jack. All are independent. The IRRs for the three projects: Manny 16% Moe 13% Jack 10% All three projects have an initial investment of $1,000,000. Acme can borrrow up to $2,000,000 from the bank at a quoted interest rate of 8%. They also have a reported $3,000,000 in Retained Earnings available for new projects. Additional information: The next common stock dividend they pay will be $4.00 per share. They also expect a growth rate of 5% on common equity. New common stock can be sold for $50.00 per share, with flotation costs of $10.00 per share. Part 1: a. Which projects would you accept and why? Yes, I need to see some "number crunching". b. What would be your capital budget? Part 2: Let's change one thing. The federal government has decided to increase the regulations affecting the manufacturing of chips. Complying with these new regulations will cost Acme $3 million, wiping out their retained earnings. So now: a. Which projects would you accept and why? More number crunching please! b. What would be their capital budget now?
Explanation / Answer
Part 2
b
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Total capital budget will be $2000000
Cost of debt 4.80% r*1-t, where r is the interest rate, the t is the tax rate Cost of Retained Earnings 13% Dividend / Market value + growth rate Cost of common stock 15% Dividend / (Market value-floatation cost) + growth rate Part 1 a AS the reatined earnings is available and company will not borrow therefore only the Manny project may be accepted as it has the IRR which is more than 13%. b Total capital budget will be $1000000Part 2
WACC for Capital structure of 40:60 10.92%( 40% x cost of debt + 60% cost of common stock) a The Manny and Joe projects are accepted as the IRR of both are more than WACC of 10.92%b
Dear Asker, Give your ratings for feedback purpose.
Total capital budget will be $2000000
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