In: Finance
"Answer all the parts in one answer"
Company B has three Projects it can choose from: Projects X, Y and Z. The following information is available regarding Project X:
Years 0 1 2 3
CF -100 80 60 40
The company’s capital structure is distributed equally between debt and preferred stock and the remaining 40% goes to common stock. It has also the following information:
1- After tax cost of debt: 3%. Tax rate: 40%
2- Preferred stocks are selling at $70 per share and pay a dividend
of $7 per share
3- Common stocks are selling at $60 per share, pay a year-end
dividend of $4 per share and grow at a constant rate of 8.59%.
The company is also considering another two projects “Y” & “Z” with the following information:
Criteria Project Y Project Z
NPV $40 $67
MIRR 11% 20%
IRR -2.0% 18.7%
Regular Payback 2.23 years 1.77 years
5) Assuming that the three projects X, Y & Z are
independent, which project (s) should the company choose:
*
a) Project Z
b) Projects X and Z
c) Projects X, Y and Z
d) Projects Y and Z
e) Reject all projects
6) Assuming that the three projects X, Y & Z are
mutually exclusive, which project (s) should the company choose:
*
a) Project Z
b) Project X
c) Projects X, Y and Z
d) Project Y
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 choose: *
a) Project Z
b) Project X
c) Projects X, Y and Z
d) Project Y
e) Reject all projects
8) Assuming that the three projects X, Y & Z are
mutually exclusive, based on MIRR criteria which project (s) should
the company choose: *
a) Project Z
b) Project X
c) Projects X, Y and Z
d) Project Y
e) Reject all projects
9) If IRR for Project X is 17.95%, and the three
project X, Y & Z are independent, then based on IRR criteria
which project (s) should the company choose: *
a) Project Z
b) Projects X and Z
c) Projects X, Y and Z
d) Projects Y and Z
e) Reject all projects
Solution:
First calculating the cost of capital of the company.
Cost of Debt (post tax) = 3.0%
Cost of preferred stock = 7/70 = 10%
Cost of equity:
Given D1 = $4 (assuming); P0 = 60, g = 8.59%
Implied cost of equity = 4/60 + 8.59% = 15.26%
The WACC is computed in table below:
So, WACC of the Company is 10.0%
Computing NPV, IRR, MIRR and Payback using excel.
We have them as under:
NPV = 52.36
MIRR = 27%
IRR = 42%
Payback = 1.33 years
Comparing the Projects:
Now answering the questions:
5) Assuming that the three projects X, Y & Z are independent, which project (s) should the company choose:
A: All three projects have NPV greater than zero and MIRR greater than cost of capital and reasonable payback period. All three can be done. (Neagtive IRR may be due to non-conventional cash flows)
6) Assuming that the three projects X, Y & Z are mutually exclusive, which project (s) should the company choose:
A: Project X, NPV is +ve and has highest MIRR, IRR and lowest payback
7) Assuming that the three projects X, Y & Z are independent, based on MIRR criteria which project (s) should the company choose:
A: All three.
8) Assuming that the three projects X, Y & Z are mutually exclusive, based on MIRR criteria which project (s) should the company choose:
A: Project X
9) If IRR for Project X is 17.95%, and the three project X, Y & Z are independent, then based on IRR criteria which project (s) should the company choose:
A: Project Z, Higher IRR, Lower backback
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