Question

Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%.

Component	Scenario 1	Scenario 2	Cost of Capital	Tax Rate
Debt	$5,000,000.00	$2,000,000.00	8%	30%
Preferred Stock	1,200,000.00	2,200,000.00	10%
Common Stock	1,800,000.00	3,800,000.00	13%
Total	$8,000,000.00	$8,000,000.00

1-a. Complete the table below to determine the WACC for each of the two capital structure scenarios. (Enter your answer as a whole percentage rounded to 2 decimal places (e.g. .3555 should be entered as 35.55).)

1-b. Which capital structure shall Mr. Johnson choose to fund the new project?

• Scenario 1

• Scenario 2

Part 2

Assume the new project’s operating cash flows for the upcoming 5 years are as follows:

	Project A
Initial Outlay	$ -8,000,000.00
Inflow year 1	1,020,000.00
Inflow year 2	1,850,000.00
Inflow year 3	1,960,000.00
Inflow year 4	2,370,000.00
Inflow year 5	2,550,000.00
WACC	?

2-a. What are the WACC (restated from Part 1), NPV, IRR, and payback years of this project? (Negative values should be entered with a minus sign. All answers should be entered rounded to 2 decimal places. Your answers for WACC and IRR should be whole percentages (e.g. .3555 should be entered as 35.55).)

2-b. Shall the company accept or reject this project based on the outcome using the net present value (NPV) method?

• Project A should be accepted

• Project A should be rejected

Answer 1

Part-1)

1-a)

1-b)

Scenario 1 should be chosen

Part-2)