Question

Jacks Construction has 80 bonds outstanding that are selling at their par value of $1000 each. Bonds with similar characteristics are yielding a pre-tax 8.6% ( pre-tax cost of debt). The firm has 4000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The US T-bill is yielding 4%, the market risk premium is 8% and the firms tax rate is 21%. The firm is considering a 5 year expansion project that costs 8 million and will generate an annual after tax cash flow of 13.5 million beginning at time 1.

Calculate the firms cost of equity capital.

Calculate the after tax. firms cost of debt

What are the weights of debt and equity

Calculate the WACC

What is the NPV of the project

Answer 1

1) Cost of equity = Rf + Beta * Market risk premium = 4 % + 1.1*8% = 12.8%

2) After tax cost of debt = 8.6%*(1-taxrate) = 8.6%*(1-0.21) = 6.79%

3) Equity = 40*4000 = 160000

DEBT = 1000*80 = 80000

Therefore weights of equity = 160000/(160000+80000) = 0.667

Weights of debt = 80000/240000 = 0.333

4) WACC = weightof equity * cost of equity + weights of debt * cost of debt = 0.667*12.8+ 0.333*6.79 = 10.798

= 10.8%

5)

Year	FCF	PVF @ 10.8%	Present value
0	(8,000,000.00)	1	$ (8,000,000.00)
1	13,500,000.00	0.90253	$ 12,184,155.00
2	13,500,000.00	0.81456	$ 10,996,560.00
3	13,500,000.00	0.73516	$    9,924,660.00
4	13,500,000.00	0.6635	$    8,957,250.00
5	13,500,000.00	0.59883	$    8,084,205.00
		NPV	$ 42,146,830.00

NOTE : [email protected]% = 1/1.108^n