A project costs $70M. It will provide additional revenue of 20M per year for 30

Question

A project costs $70M. It will provide additional revenue of 20M per year for 30 years while also costing 5M per year to run. It will require an addition to net working capital of 3M for the life of the project. Project will be depreciated straight line to zero over the project's life. The tax rate is 35%. The investment is expected to be sold for scrap for $500,000 at the end of the project. Let the T-bill rate be 1%, the company's beta is 1.1. Let the market risk premium be 8%. The preferred dividend is $10. The price of the preferred stock is $80. The company has 100,000 bonds priced at $980. The coupon rate is 7% and the time to maturity is 8 years. The company has 100,000 shares of preferred priced at 580. The company has 1M shares of common priced at 550 The company's dividends growth at 3% per year. The next dividend is $3.50. Cost of equity is 10% 1 What is cost of equity using CAPM model? 2 What is cost of equity using dividend growth model? 3) What is the cost of equity that is average of CAPM and dividend growth 4) What is cost of debt? 5) What is cost of preferred? 6) What is market value of equity

Explanation / Answer

1) Using CAPM, Cost of equity, ke = Rf + beta x MRP = 1% + 1.1 x 8% = 9.8%

2) Using dividend growth model, Cost of equity, ke = D1/ P + g = 3.5 / 50 + 3% = 10%

3) Average cost of equity = (9.8% + 10%) / 2 = 9.9%

4) Cost of debt can be calculated using I/Y function

N = 8, PMT = 7% x 1000 = 70, PV = -980, FV = 1000 => Compute I/Y = 7.34% is cost of debt

5) Cost of preferred = Dividend / Price = 10 / 80 = 12.5%

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