Question

1. ( A ) What is the WACC (weighted cost of capital) for a company if it borrows from two sources: bank loan of 25 million at 6% per compounded monthly, and retained earning of 10 million with earnings per share of 35 cents and price per share 14.00 dollars. Income tax rate is 35%.

( B )When using the “longest life” planning horizon what issue (or issues) might you have to consider for alternatives whose cash flow profiles are shorter than the “longest life”?

- Choice a    determination of salvage values for any truncated cash flows

- Choice b    the validity of the assumption that cash flow profiles are repetitive

- Choice c    both choice a and choice b

- Choice d    Neither choice a nor choice b

( C ) . What is the future worth of the following: At t = 1 you deposit 10,000   At t= 2 you deposit 10,500 .   Every year you increase your deposit amount by 500.   This goes on until t = 60.   I = 6%. How much is in the account at t = 60?

Answer 1

1. ( A ) What is the WACC (weighted cost of capital) for a company if it borrows from two sources: bank loan of 25 million at 6% per compounded monthly, and retained earning of 10 million with earnings per share of 35 cents and price per share 14.00 dollars. Income tax rate is 35%.

Ans (A) Weighted average cost of capital is calculated as follows:

No. of source of capital : 2

Bank Loan : Amount 25 million, Cost 6% compounded monthly.(Annually it is 6.17 by compound interest formula)

Retained Earnings : Amount 10 million, Cost of retained earning is 3.85%

Calculation of Cost of retained earnings is 35 out of 14.00 dollars, but this is earning after tax.

if we calculte earning befor tax (as this is mostly calculated for WACC) and income tax is 35%.

earning before tax paid is 53.85 cents out of 14.00 dollars. so the Cost of retained earning is 3.85%

Options	Amount (in Millions)	Weight	Cost (Annually)	Multiplication
Bank Loan	25	25	6.17	154.25
Retained Earnings	10	10	3.85	38.5
Total		35		192.75

So weighted avg. cost of capital is 5.507 ( as calculated by 192.75 / 35)

( B )When using the “longest life” planning horizon what issue (or issues) might you have to consider for alternatives whose cash flow profiles are shorter than the “longest life”?

- Choice a    determination of salvage values for any truncated cash flows

- Choice b    the validity of the assumption that cash flow profiles are repetitive

- Choice c    both choice a and choice b

- Choice d    Neither choice a nor choice b

Answer si Choice b : as a plannign horizon is mostly concerned with degrees of uncertainty in environment which may effect future cashflow and longterm planning as well. so "the validity of the assumption that cash flow profiles are repetitive" is much more important than salvage value. Salvage value is also a source of cashflow and it would be considered as well but not as important as cashflow profiles are repetitive.

( C ) . What is the fwuture worth of the following: At t = 1 you deposit 10,000   At t= 2 you deposit 10,500 .   Every year you increase your deposit amount by 500.   This goes on until t = 60.   I = 6%. How much is in the account at t = 60?

Ans: $ 9830458 (Total of all future values)

Seperately calculate FV for each period and add them all.

Year	Amount	Interest rate	Remaining Term	FV
1	10000	6	60	329876.9
2	10500	6	59	326764.9
3	11000	6	58	322948.2
4	11500	6	57	318516.7
5	12000	6	56	313552.1
6	12500	6	55	308129
7	13000	6	54	302315.3
8	13500	6	53	296172.4
9	14000	6	52	289756.4
10	14500	6	51	283117.8
11	15000	6	50	276302.3
12	15500	6	49	269351.3
13	16000	6	48	262301.9
14	16500	6	47	255187.6
15	17000	6	46	248038.3
16	17500	6	45	240880.7
17	18000	6	44	233738.7
18	18500	6	43	226633.4
19	19000	6	42	219583.6
20	19500	6	41	212605.8
21	20000	6	40	205714.4
22	20500	6	39	198921.9
23	21000	6	38	192239.3
24	21500	6	37	185675.9
25	22000	6	36	179239.5
26	22500	6	35	172937
27	23000	6	34	166773.6
28	23500	6	33	160753.9
29	24000	6	32	154881.3
30	24500	6	31	149158.5
31	25000	6	30	143587.3
32	25500	6	29	138168.9
33	26000	6	28	132903.9
34	26500	6	27	127792.2
35	27000	6	26	122833.3
36	27500	6	25	118026.4
37	28000	6	24	113370.2
38	28500	6	23	108862.9
39	29000	6	22	104502.6
40	29500	6	21	100287.1
41	30000	6	20	96214.06
42	30500	6	19	92280.78
43	31000	6	18	88484.51
44	31500	6	17	84822.34
45	32000	6	16	81291.25
46	32500	6	15	77888.14
47	33000	6	14	74609.83
48	33500	6	13	71453.1
49	34000	6	12	68414.68
50	34500	6	11	65491.3
51	35000	6	10	62679.67
52	35500	6	9	59976.5
53	36000	6	8	57378.53
54	36500	6	7	54882.5
55	37000	6	6	52485.21
56	37500	6	5	50183.46
57	38000	6	4	47974.12
58	38500	6	3	45854.12
59	39000	6	2	43820.4
60	39500	6	1	41870