A firm has a Capital Structure as follows: The market value of the bonds is $2,0
ID: 2793238 • Letter: A
Question
A firm has a Capital Structure as follows:
The market value of the bonds is $2,000,000,
The market value of the Preferred Stock is $1,000,000.
Firm has 500,000 shares of common stock (equity) outstanding, selling for $20 per share
The preferred stock share price is $50 and which a $4 dividend. Each share of common stock sells for $20 and pays a $1.00 dividend, which is expected to grow by 2% per year. The price of the bonds is $818, and the coupon rate is 5%. The bonds will mature in 10 years.
The firm’s tax rate is 40%. The company has $2,500,000 in sales, and expenses of $1,000,000. The initial investment of $5,000,000 will be depreciated straight-line over 10 years. The project is expected to last 10 years.
What is the firm’s WACC? ________________________________Chapter 13 ( to solve this question you must use the cost of preferred stock, cost of the common stock and cost of the bonds from Mini case 2-part 1)
What is the firm’s OCF ___________________________________Chapter 9
What is the NPV, using the WACC (use the answer from question 1 above), and OCF (use the answer from question 2 above)? ______________________Chapter 8
Based on your answer to question #3, will to accept the project?
Explanation / Answer
Value of equity = No. of shares x Share Price = 500,000 x 20 = 10,000,000
Weight of equity, we = Value of equity / Total Value = 10m / 13m = 77%
Weight of debt, wd = 2 / 13 = 15%
Weight of preferred stock, wps = 1 / 13 = 8%
Cost of equity, ke = D0 x (1 + g) / P + g = 1 x (1 + 2%) / 20 + 2% = 7.10%
Cost of preferred stock, kps = D / P = 4 / 50 = 8.00%
Cost of debt can be calculated using I/Y function on a calculator or RATE function in excel
N = 10, PMT = 5% x 1000 = 50, PV = -818, FV = 1000 => Compute I/Y = 7.67% = wd
WACC = we x ke + wps x kps + wd x kd x (1 - tax)
= 77% x 7.10% + 8% x 8% + 15% x 7.67% x (1 - 40%)
= 6.79%
OCF = (Sales - Expenses - Depreciation) x (1 - tax rate) + Depreciation
= (2,500,000 - 1,000,000 - 5,000,000 / 10) x (1 - 40%) + 5,000,000 / 10
= 1,100,000
PV of future cash flows can be calculated using PV function
N = 10, PMT = 1,100,000, I/Y = 6.79%, FV = 0 => Compute PV = $7,803,258.86
=> NPV = 7,803,258.86 - 5,000,000 = $2,803,258.86
As NPV > 0, accept the project.
Value Weight Cost Equity 10,000,000 77% 7.10% Preferred 1,000,000 8% 8.00% Debt 2,000,000 15% 7.67% Total 13,000,000 WACC 6.79%Related Questions
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