Question

Question 1 Swirlpool, Inc., has found that its cost of common equity capital is 16 percent, and its cost of debt capital is 9 percent. If the firm is financed with 60 percent common shares and 40 percent debt, then what is the after-tax weighted average cost of capital for Swirlpool if it is subject to a 40 percent marginal tax rate?

Group of answer choices 6.43% 9.64% 11.76% 15.29%

Question 2pts Vanderheiden Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $8,000 and will produce net cash flows of $5,000 per year for 2 years. Process L will cost $11,500 and will produce cash flows of $4,000 per year for 4 years. The company has a contract that requires it to produce the shirts for 4 years, but the patent will expire after 4 years, so the shirts will not be produced after 4 years. Inflation is expected to be zero during the next 4 years. If cash inflows occur at the end of each year, and if Vanderheiden's required rate of return is 10 percent, by what amount will the better project increase Vanderheiden's value?

Group of answer choices $1,098.89 $677.69 $1,237.76 $1,179.46 $1,312.31

Question 3 Marley's Pipe Shops has found that its common equity capital shares have a beta equal to 1.84 while the risk-free return is 5 percent and the expected return on the market is 11 percent. Its cost of debt financing is 11 percent. If the firm is financed with $240,000,000 of common equity (market value) and $145,000,000 of debt (market value), then what is the after-tax weighted average cost of capital for Marley's if it is subject to a 40 percent marginal tax rate?

Group of answer choices 11.23% 14.14% 12.48% 13.73%

Answer 1

1) The after-tax weighted average cost of capital can be calculated by the following formula :-

where, WACC = after-tax weighted average cost of capital

E = total market value of the fim's common equity capital

D = total market value of the firm's debt capital

V = (E+D) = total market value of the firm's capital structure

E/V = proportion of the firm's common share capital

D/V = proportion of the firm's debt capital

K_e = cost of equity capital of the firm

K_d = cost of debt capital of the firm

t = corporate tax rate

The data we get from the above problem:-

E/V = 60% or, 0.60

D/V = 40% or, 0.40

K_e = 16% or, 0.16

K_d = 9% or, 0.09

t = 40% or,0.40

Hence, the WACC for Swirlpool Inc. can be calculated as follows :-

or, WACC = (0.6 * 0.16) + (0.4 * 0.09) (1 - 0.40)

= 0.096 + (0.036 * 0.60)

= 0.096 + 0.0216

= 0.1176

= 11.76%

Therefore, the after tax WACC for Swirlpool Inc. = 11.76%

2) We need to calculate the Net Present Value of each of the process S & L. The NPV can be calculated by the following formula :-

where, CF = cash flows of the project for the years 1, 2,3,...,n

n = total no. of years

i = cost of capital or the discount rate for the firm

We get the following data from the above given problem:-

i = 10% for the firm

For process S:-

Initial Investment = $8000

Net cash flows for two years = $5000

The project will last for 4 years so that the machine will be purchased 2 times. Once at the initial outlay and another at the beginning of the 3rd year.

Calculation of the Present Value of the CFs :-

Year	Cash outflow in $	Cash Inflow in $	PV factor at 10% discount rate	Present Value in $
0	(8000)			(8000)
1		5000	0.909	4545
2	(8000)	5000 - 8000 = -3000	0.826	(2478)
3		5000	0.751	3755
4		5000	0.683	3415

Therefore, the NPV for Process S = $ { -8000 + 4545 - 2478 + 3755 + 3415} = $1237

The initial outlay for the process L = $11,500

Calculation of the Present Value of the CFs for Process L:-

Year	Cash outflow in $	Cash Inflow in $	PV factor at 10% discount rate	Present Value in $
0	(11,500)			(11,500)
1		4000	0.909	3636
2		4000	0.826	3304
3		4000	0.751	3004
4		4000	0.683	2732

Therefore, the NPV of Process L = $(3636 + 3304 + 3004 + 2732) - $11,500 = $12,676 - $11,500 = $1,176

Hence, Process S is the better project and it adds value by $1,237.

(3)

The after-tax weighted average cost of capital can be calculated by the following formula :-

where, WACC = after-tax weighted average cost of capital

E = total market value of the fim's common equity capital

D = total market value of the firm's debt capital

V = (E+D) = total market value of the firm's capital structure

E/V = proportion of the firm's common share capital

D/V = proportion of the firm's debt capital

K_e = cost of equity capital of the firm

K_d = cost of debt capital of the firm

t = corporate tax rate

Here, its given, The value of equity (E) = $240,000,000
The value of Debt capital (D) = $145,000,000

The total value of the firm (V) = $240,000,000 + $145,000,000 = $385,000,000

Therefore, E/V = $240,000,000 / $385,000,000 = 0.6233

And, D/V = $145,000,000 / $385,000,000 = 0.3766

Its given that,

K_d = 11% or, 0.11

t = 40% or, 0.40

We can calculate the cost of equity or K_e from the CAPM formula :- K_e = R_f + b (K_m - R_f)

where, R_f = risk free return rate

K_m = market return rate

b = beta coefficient

Here, its given,

R_f = 5% or, 0.05

K_m = 11% or, 0.11

b = 1.84

Hence, K_e = R_f + b (K_m - R_f) = 0.05 + 1.84 (0.11 - 0.05) = 0.1604

Therefore, WACC is given by :

or, WACC = (0.6233 * 0.1604) + (0.3766 * 0.11) (1 - 0.40)

= 0.1248 or, 12.48%

Therefore, the required WACC = 12.48%