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In: Finance

HOW WOULD YOU COMPUTE THIS BY HAND AND USING A TI-84 CALCULATOR? WHAT ARE THE STEPS...

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

  1. 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?

  2. What is Despondus Corporation's after-tax cost of debt?
  3. What is Despondus Corporation's weighted average cost of capital (WACC)?
  4. What is the net present value of the project? (Round to the nearest dollar.)
  5. Should the project be accepted? Explain your answer; a simple 'yes' or 'no' will result in no points for this part of the question

Solutions

Expert Solution

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:

  • Press the CF button.
  • CF0= -$264,000. It is entered with a negative sign since it is a cash outflow.
  • Cash flow for each year should be entered.
  • Press Enter and down arrow after inputting each cash flow.
  • After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 9.99%.
  • Press enter after that. Press the down arrow and CPT buttons to get the net present value.

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.


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