In: Finance
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
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.