Question

Problem 2: Given the net cash flows for Project X (over 3-years) for Aberdeen Company Year CF 0-$300,000 1 $120,000 2 $128,000 3 $155,000 The company's capital structure is distributed equally between debt, preferred stock, common stock and new common stock. It has also the following information: 1- After tax cost of debt: 5.4%. Tax rate: 40% 2- Preferred stocks are selling at $80 per share and pay a dividend of $8 per share 3- Common stocks are selling at $50 per share, pay a year-end dividend of $3 per share and grow at a constant rate of 6%. When issuing new common stock, a 10% flotation cost would be incurred. The company is also considering another two projects "Y" & "Z" with the following information: Projects Y Z NPV $20,100.3 $37,320.2 MIRR 9.2% 14.5% IRR 7.77% 15.04% Payback period in years 4.1 1.64 Noted. 5. Assuming that the three projects X, Y & Z are independent, which project (s) should the company accept? * A. Project X B. Project Y C. Only Projects X & Z D. All E. Reject all projects 6. Assuming that the three projects X Y & Z are mutual exclusive, and which project (s) should the company accept? A. Project X B. Project Y C. Project Z D. All E. Reject all projects 7. Assuming that the three projects X, Y & Z are independent, based on MIRR criteria which project(s) should the company accept? A Project X B. Project Z C. Projects X, Y & Z D. Only Projects X & Z E Reject all projects

Answer 1

Answer:-

Year	Cash Flow
0	$300,000
1	$120,000
2	$128,000
3	$155,000

After-Tax Cost of debt	5.40%
Tax Rate	40.00%
Preferred Dividend	8
Preferred Stock price	80
Current Selling Price	50
Dividend per share	3
Growth Rate	6%
Flotation cost	10%

Capital Structure	Weights
A	33.33%
B	33.33%
C	33.33%

1. Calculation of Cost of preferred stock	10%
2. Calculation of Cost of Equity	12.67%
3. Calculation of WACC	9.36%

Year	Cash Flow	Discount Rate	PV Factor	PV of Item
0	-300000	9.36%	1	-300000
PV of cash outflows	300000

Year	Cash Flow	Discount Rate	PV Factor	PV of Item
1	120000	9.36%	1.196	143515.32
2	128000	9.36%	1.093	139980.8
3	155000	9.36%	1	155000
FV of Cash outflows	438496.12

Year	Cash Flow	Cumulative Cash Flows	PVF	PV of cash flow	Cumulative PV of Cashflow
0	-300000	-300000	1	-300000	-300000
1	120000	-180000	0.914	109729.33	-190270.6
2	128000	-52000	0.836	107026.9	-83243.76
3	155000	103000	0.765	118510.33	35266.57

NPV	35266.57
MIRR	13.49%
Payback period	2.34
Discounted Payback period	2.7

Parameters	X	Y	Z
NPV	35266.57	20100.3	37320.2
MIRR	13.49%	9.20%	14.50%
Payback period	2.34	4.1	1.64
IRR	15.59%	7.77%	15.04%

Part:5 - The Correct option is D - ALL ( All Projects have Positive NPV, Accept all)

Part 6:- The correct Option is C - Project Z (Highest NPV)

Part 7:- The correct Option is D - Only Project X&Z (MIRR>WACC)