Speedy Delivery Systems can buy a piece of equipment that is anticipated to prov

Question

Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide a return of 11 percent and can be financed at 8 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a return of 15 percent but would cost 17 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital structure. a. Compute the weighted average cost of capital. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

2. A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $200,000 a year for the next 40 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 12 percent.

What is the difference between the present value of the settlement at 4 percent and 12 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

What is the difference between the present value of the settlement at 4 percent and 12 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Explanation / Answer

1)

weighted average cost of capital = Weight of Equity*Cost of Equity + Weight of Debt*After tax cost of debt

weighted average cost of capital = 50%*17% + 50%*8%

weighted average cost of capital = 12.5%

2)

Present value of the settlement at 4 percent = Annual Cash Flow*(1-(1+r)^-n)/r

Present value of the settlement at 4 percent = 200000*(1-(1+4%)^-40)/4%

Present value of the settlement at 4 percent = $ 3,958,554.78

Present value of the settlement at 12 percent = Annual Cash Flow*(1-(1+r)^-n)/r

Present value of the settlement at 12 percent = 200000*(1-(1+12%)^-40)/12%

Present value of the settlement at 12 percent = $ 1,648,755.34

Difference between the present value of the settlement at 4 percent and 12 percent = $ 3,958,554.78 - $ 1,648,755.34

Difference between the present value of the settlement at 4 percent and 12 percent = $ 2,309,799.44

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.