Question

Hashem Hats Inc. needs to develop an estimate of its cost of capital. Assume that you are an assistant to the financial vice president. He has provided you with the following information:

The firm’s marginal tax rate is 40%. The current price of the firm’s 12 percent coupon, semiannual payment bonds with 15 years remaining to maturity is $1,153.72. The current price of the firm’s 10% $100 par value quarterly dividend perpetual preferred stock is $110.00. TSI’s common stock is currently selling at $50 per share. Its last dividend was 4.19, and dividends are expected to grow at a constant rate of 5 % forever. The firms’s beta is 1.2, the yield on T-bills is 7 percent, and the market risk premium is estimated to be 6%. For the bond yield plus risk premium approach, the firm uses a 4% risk premium. The firm estimates that if it issues new common stock, the flotation cost will be 15 percent. TSI’s capital structure is 30 percent debt, 10 percent preferred stock, and 60 percent common equity. The firm’s component cost of equity is 14% The firm has $1 million in its retained earnings account. Ignore all extraneous information in the above passage. Please provide the following, showing all work:

Calculate the firm’s component cost of debt and component cost of preferred stock. Then, asssume that Hashem Inc. is considering a single project this capital budgeting period, labeled Project C. This 3 year project has an initial cost of $100 dollars and pays three annual cash flows of $50 at the end of each year. Find the NPV of Project C. Show all work.

Answer 1