LP Inc. has 1,100 bonds outstanding that are selling for $992 each. The bonds ca
ID: 2744836 • Letter: L
Question
LP Inc. has 1,100 bonds outstanding that are selling for $992 each. The bonds carry a 6.0 percent coupon, pay interest semi-annually, and mature in 7.5 years. The company also has 9,500 shares of 5% preferred stock at a market price of $40 per share. This month, the company paid an annual dividend in the amount of $1.20 per share. The dividend growth rate is 5.0 percent. The common stock is priced at $30 a share and there are 34,500 shares outstanding. The company is considering a project that is equally as risky as the overall company. This project has initial costs of $630,000 and operating cash flows of $150,000 a year for the next 10 years and salvage value of $10,000 at the end of 10 years. The net working capital (NWC) is expected to increase by $10,000 a year until the end of the project life.. The project will be depreciated straight-line to zero over the project’s 10-year life. The tax rate is 34%.
(10 points) What is LP’s weighted average cost of capital?
(10 points) What is the net present value (NPV) of this project? Should you accept the project? Explain why.
(5 points) What is the internal rate of return (IRR) of this project? Should you accept the project if you apply the IRR decision rule?
Explanation / Answer
(a)
(b)
(c)
Step-1: Calculate individual cost of, Current price 992 Bond = Average income/Average investment Face Value 1000 (Kd) = [{30+(1000-992)/15}/{(1000+992)/2}] Coupon rate 6% = 3% life 7.5 Years Half yearlu adjustment, Cost of preferred stock = 5% Coupon rate 3% (Kp) No. of period 15 Cost of common stock = 9% Coupon payment 30 (Ke) Ke = {D0*(1+g)/P}+g D0 1.2 = {1.2*(1+.05)/30}+.05 g 5% = 9% P 30 Step-2: Calculate weight of individual: No. Value per unit Total unit Weights Bonds 1100 992 1091200 0.4 Prefered stock 9500 40 380000 0.2 Common Stock 34500 30 1035000 0.4 Total 2506200 1.0 Step-3: Calculate WACC WACC = Cost of debt *(1-tax rate)*Weight of deb + Cost of preferred stock *Weight of preferred stock + Cost of common stock *Weight of common stock = 3*(1-.34)*.4 + 5*.2 + 9*.4 = 5.39% Thus, WACC is 5.39%Related Questions
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