In: Finance
HOW WOULD YOU COMPUTE THIS BY HAND AND USING A TI-84 CALCULATOR? WHAT ARE THE STEPS FOR THE CALCULATOR? also for 2, how do you calculate PMT for TVM solver on Calc
Consider the after-tax cash flows below from a project that is being considered by Despondus Corporation. Since the project is an extension of the firm's current business, it carries the same risk as the overall firm.
Year | 0 | 1 | 2 | 3 | 4 | 5 |
Cash Flow | -$264,000 | $92,000 | $66,000 | $95,000 | $95,000 | $102,000 |
Despondus Corporation's common stock is currently priced at $80.89, and there are 516,000,000 shares outstanding. A dividend of $4.24 per share was just paid, and dividends are expected to grow at a constant rate of 5.18% per year.
The company has 6,130,000 bonds outstanding that mature in 19 years and are currently priced at $932 per bond. The coupon rate is 6.67%, and the bonds make semiannual interest payments. The company's tax rate is 17%.
1. What is Despondus Corporation's after-tax cost of equity?
First, the cost of equity is calculated using the dividend discount model.
It is calculated using the below formula:
Ke=D1/Po+g
where:
D1= Next year’s dividend
Po=Current stock price
g=Firm’s growth rate
Ke= $4.24*(1 + 0.0518)/ $80.89 + 0.0518
= $4.4596/ $80.89 + 0.0518
= 0.0551 + 0.0518
= 0.1069*100
= 10.69%.
The cost of debt is calculated by computing the yield to maturity.
Information provided:
Par value= future value= $1,000
Time= 19 years*2= 38 semi-annual periods
Coupon rate= 6.67%/2= 3.3350%
Coupon payment= 0.0334*1000= $33.40
Current price= present value= $932
The yield to maturity is calculated by entering the below in a financial calculator:
FV= 1,000
N= 38
PMT= 33.40
PV= -932
Press the CPT key and I/Y to compute the yield to maturity.
The value obtained is 3.6749.
Therefore, the before tax cost of debt= 3.6749%*2= 7.3497%
Total value of debt= 6,130,000*$932= $5,713,160,000
Total value of equity= 516,000,000*$80.89= $41,739,240,000
Total firm value= $5,713,160,000 + $41,739,240,000= $47,452,400,000
Weight of firm debt= $5,713,160,000/ $47,452,400,000
= 0.1204*100= 12.04%
Weight of equity= $41,739,240,000/ $47,452,400,000
= 0.8796*100
= 87.86%
After tax cost of debt= before tax cost of debt*(1 – 0.17)
= 7.3497%*(1 – 0.17)
= 4.8508% 4.85%
The weighted average cost of capital is calculated using the below formula:
WACC=Wd*Kd(1-t)+ We*Ke
where:
Wd= Percentage of debt in the capital structure.
Kd= The before tax cost of debt
We=Percentage of equity in the capital structure
Ke= The cost of common equity.
T= Tax rate
= 0.1204*4.85% + 0.8796*10.69%
= 0.5839% + 9.4029%
= 9.9868% 9.99%
Net present value is calculated using a financial calculator by inputting the below:
The net present value of cash flows is $73,866.37.
The project should be accepted since it generates a positive net present value.
In case of any query, kindly comment on the solution.