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WACC and NPV calculation SHOW ALL WORK !!!! Calculate the Components of WACC and the WACC...

WACC and NPV calculation SHOW ALL WORK !!!! Calculate the Components of WACC and the WACC Use 4 decimals. Cost of Debt:30 year Bonds Current Price 105.5% of par value 7.6 % Coupon Rate Semi Annual Bond 5 years to maturity Tax Rate: 40%. What is the Cost of Debt after tax? Preferred Stock Dividend $7.50 Current Price $60.00. What is the Cost of Preferred? Equity Risk Free Rate 6.50% Market Risk Premium 6.25% Stock Beta 0.7 What is the Cost of Equity? Market Value...Debt/Equity 10,000 Bonds Outstanding Selling @ 105.5% of Par Value 43,000 Preferred Stock @ $60.00 300,000 Shares of Common Stock @ $40.00 per share What is the WACC? Given the WACC Calculate the NPV for the following capital budgeting decision, Investment is: $400,000 Cash Flows: 1st Year -55,000 2nd Year 65,000 3rd Year 75,000 4th Year 85,000 5th Year 150,000 NPV is? Decision (Circle One) Accept Reject, Calculate Payback

Solutions

Expert Solution

Cost of debt using approximation formula:

Since par value is not given , lets assume par value to be $100.

( Generally bonds have par value of $100 or $1000)

Price of bond = 105.5% of 100 = $105.5

Number of periods = 5 * 2 = 10 ( since it is asemi annual bond, we multiply by 2)

Coupon payment = 7.6% of 100 = 7.6 / 2 = 3.8 ( since it is asemi annual bond, we divide by 2)

Yield to maturty = ?

Approx YTM = [C + (F - P) / N] / ( F + P) / 2

Approx YTM = [3.8 + (100 - 105.5) / 10] / ( 100 + 105.5) / 2

Approx YTM = [3.8 + ( - 0.55)] / 102.75

Approx YTM = 3.25 / 102.75

Approx YTM = 0.03163 or 3.163

To annualize the YTM, we multiply with 2 = 3.163 * 2 = 6.326%

Cost of debt using a financial calculator:

Keys to use in a financial calculator: FV = 100, PV = -105.5, N = 10, PMT = 3.8, CPT I/Y)

Once you click CPT I/Y you will get 3.15078.

To annualzie this rate we multiply by 2 = 3.15078 * 2 = 6.3005%

Note: there would be slight difference when calculating yield to maturity using approx formula and financial calculator. For furthur calculations, i will be using cost of debt of 6.3005% as generally a financial calculator is used to calculate YTM)

Before tax cost of debt = 6.3005%

After tax cost of debt = 0.063005 ( 1 - tax)

After tax cost of debt = 0.063005 ( 1 - 0.4)

After tax cost of debt = 0.037803 or 3.7803%

Cost of preferred equity = dividend / current price

Cost of preferred equity = 7.5 / 60

Cost of preferred equity = 0.125 or 12.5%

Cost of equity using CAPM method = Risk free rate + beta ( market risk premium)

Cost of equity using CAPM method = 0.065 + 0.7 ( 0.0625)

Cost of equity using CAPM method = 0.10875 or 10.875%

Market value of debt = 10,000 * 105.5 = 1,055,000

Market value of preferred stock = 43,000 * 60 = 2,580,000

Market value of equity = 300,000 * 40 = 12,000,000

Total market value = 1,055,000 + 2,580,000 + 12,000,000

Total market value = 15,635,000

Weigth of debt = 1,055,000 / 15,635,000 = 0.067477

Weight of preferred stock = 2,580,000 / 15,635,000 = 0.165014

Weight of equity =  12,000,000 / 15,635,000 = 0.767509

WACC = weight of debt * cost of debt + weight of preferred stock * cost of preferred stock + weight of equity + cost of equity

WACC = 0.067477 * 0.037803 + 0.165014 * 0.125 + 0.767509 * 0.10875

WACC = 0.002551 + 0.020627 + 0.083467

WACC = 0.106645 or 10.6645%

NPV = present value of casf inflows - present value of cash outflows

Since 55,000 has a negative sign, 55,000 will be a cash outflow

Present value of cash outflows = 400,000 + 55,000 / ( 1 + 0.106645)1

Present value of cash outflows = 400,000 + 49,699.7682

Present value of cash outflows = $449,699.7682

Present value of cash inflows = 65,000 / ( 1 + 0.106645)2 + 75,000 / ( 1 + 0.106645)3 + 85,000 / ( 1 + 0.106645)4 + 150,000 / ( 1 + 0.106645)5

Present value of cash inflows = 53,075.819 + 55,339.6343 + 56,674.229 + 90,375.2742

Present value of cash inflows = 255,464.9566

NPV = 255,464.9566 - 449,699.7682 = -194,234.8116

Since it has a negative NPV, the project should NOT be accepted. Project should be rejected.

Payback:

Cumulative cash flow for year 0 = -400,000

Cumulative cash flow for year 1 = -400,000 + (-55,000) = -455,000

Cumualtive cash flow for year 2 = -455,000 + 65000 = -390,000

Cumulative cash flow for year 3 = -390,000 - 75000 = -315,000

Cumulative cash flow for year 4 = -315,000 + 85000 = -230,000

Cumulative cash flow for year 5 = -230,000 + 150,000 = -80,000

The payback for the project is zero since the cash flows does not recover the investment.


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