Question

A firm is deciding on a new project. Use the following information for the project evaluation and analysis:

        - The initial costs are $900,000 for fixed assets. The fixed assets will be depreciated straight line to a zero book value over the 3-year life of the project. The fixed assets have an estimated salvage value of $60,000 at the end of the project.

        - The project also requires an additional $200,000 for net working capital. All of the net working capital will be recouped at the end of the 3 years.

        - The project is expected to generate sales of $2,000,000 (2,000 units at a sales price of $1,000/unit), incur total costs of $1,500,000 per year (comprised of variable cost of $500 per unit and fixed costs of $500,000).

        - The firm’s marginal tax rate is 40 percent.

- The company has 50,000 shares of common stock outstanding at a market price of $25 a share. The stocks have a beta of 1.5. The risk free rate is 1%, and the market risk premium is 10%.

        - There are 1,000 bonds outstanding which mature in 13 years, have a face value per bond of $1,000, and are currently quoted at $1,250 each. The bonds have a coupon rate of 10 percent.

        - The target capital structure is 50% debt and 50% equity.

A) What is the capital structure weight of equity (w_E)?

      B) What is the capital structure weight of debt (w_D)

      C) What is the cost of Debt (R_D)?

      D) What is the cost of Equity (R_E)?

     

Answer 1