Question
Diane was recently hired by Jackson Solar Corp. as a junior budget analyst She is working for the Venture Capital Division and has been given for capital budgeting projects to evaluate. She must give her analysis and recommendation to the capital budgeting committee on Friday July 31 Diane has a B.S. in accounting from CWU (2007) and passed the CPA exam (2008) She has been in public accounting for 2 years. During thattime she earned an MBA from Seattle U. She would like to be the CFO of a company someday-maybe Jackson Solar Corp and this is an opportunity to get onto that career track and to prove her ability As Diane looks over the financial data collected, she is trying to make sense of it all. She already has the most difficult part of the analysis complete-- the estimation of cash flows. Through some internet research and application of finance theory she has also determined the firm's beta Here is the information that Diane has accumulated so far The Capital Budgeting Projects
Explanation / Answer
1. The firm's cost of Debt Using PV of ordinary annuity formula, PV of the bond= PV of its future coupons+ PV of Face value to be received at maturity PV/Current Price of the bond=Coupon*(1-(1+r)^-n)/r+(FV/(1+r)^10) 1080=((12%/2*1000)*(1-(1+r)^-10)/r)+(1000/(1+r)^10) Solving for r will give the semi annual r r= 0.04966 Annual r=1 .04966^2-1= 0.10179 10.18% After-tax cost of debt=Before-tax cost*(1-Tax rate) ie. 0.1018*(1-40%) 6.11% 2. Cost of Preferred stock Current annual $ Dividend/Current market price (100*11%)/104= 10.58% 3. Cost of common equity i. Using CAPM Ke=RFR+(Beta*(Market Risk Premium)) Ke=2.5%+(1.3*(10%-2.5%)) 12.25% ii. Using DCF approach (Next dividend/Current market price)+Growth Rate ((3*1.09)/94)+0.09= 12.48% iii. Bond-Yield +Risk premium approach: Bond-Yield as 1 above= 10.18% Ke=Before-tax bond Yield+Risk premium Ke=10.18%+2.8%= 12.98% 4. Final estimate is the CAPM approach So, Ke= 12.25% 5&6 Jackson Solar Corp.'s Overall WACC (0.40*0.0611)+(0.10*0.1058)+(0.50*0.1225)= 0.09627 9.63% WACC for High risk (0.40*0.0611)+(0.10*0.1058)+(0.50*0.1298)= 9.99% WACC for Average risk (0.40*0.0611)+(0.10*0.1058)+(0.50*0.1248)= 9.74% WACC for Low risk Overall WACC --9.63%
A Risk High Year PV F at 9.99% PV at 9.99% 0 -25000000 1 -25000000 1 7500000 0.90917 6818802 2 7500000 0.82660 6199474 3 7500000 0.75152 5636398 4 7500000 0.68326 5124464 NPV of the project -1220862 IRR 7.71% MIRR 8.62% B Risk Average Year PV F at 9.74% PV at 9.74% 0 -24600000 1 -24600000 1 11000000 0.91124 10023692 2 9000000 0.83037 7473303 3 6000000 0.75667 4540006 4 4000000 0.68951 2758038 NPV of the project 195039 IRR 10.17% MIRR 9.96% C Risk Average Year PV F at 9.74% PV at 9.74% 0 -19000000 1 -19000000 1 6200000 0.91124 5649718 2 6200000 0.83037 5148275 3 6200000 0.75667 4691339 4 6200000 0.68951 4274958 NPV of the project 764290 IRR 11.58% MIRR 10.83% D Risk Low Year PV F at 9.63% PV at 9.63% 0 -22000000 1 -22000000 1 4600000 0.91216 4195932 2 7600000 0.83203 6323460 3 8800000 0.75895 6678738 4 8800000 0.69228 6092072 NPV of the project 1290202 IRR 12.04% MIRR 11.20%
