Question

Glasgow company has the following financial data for project X (3-year project): Year 0 Year 1 Year 2 Year 3 CF -10,000 5,000 4,000 4,000 The company’s capital structure is distributed equally between debt, preferred stock and common stock. It has also the following information: 1- After tax cost of debt: 5.8%. Tax rate: 40%

2- Preferred stocks are selling at $65 per share and pay a dividend of $8 per share

3- Common stocks are selling at $40 per share, pay a year-end dividend of $2 per share and grow at a constant rate of 13%.

The company is also considering another two projects “Y” & “Z” with the following information: Criterion Project Y Project Z Payback Period 2.56 years 3 years NPV $678.98 $282.24 IRR 15.19% 16% MIRR 14.48% 15%

5. Assuming that the three projects X, Y & Z are independent, which project (s) should the company choose? *

A. X, Y & Z

B. X & Z

C. Only X

D. Only Y

E. Reject all projects

6. Assuming that the three projects X, Y & Z are Mutual Exclusive, which project (s) should the company choose? *

A. X, Y & Z

B. X & Z

C. Only X

D. Only Y

E. Reject all projects

7. Assuming that the three projects X, Y & Z are independent, then based on MIRR criteria which project (s) should the company choose? *

A. X, Y & Z

B. X & Y

C. Only X

D. Only Z

E. Reject all projects

8. Assuming that the three projects X, Y & Z are Mutual Exclusive, then based on MIRR criteria which project (s) should the company choose? *

A. X, Y & Z

B. X & Y

C. Only X

D. Only Z

E. Reject all projects

9. If IRR for “X” is 15.02%, and the three projects X, Y & Z are Independent, based on IRR criteria which project (s) should the company choose? *

A. X, Y & Z

B. X & Y

C. Only X

D. Only Y

E. Reject all projects

10. Belanger Construction is considering the following project. The project has an up-front cost and will also generate the following subsequent cash flows. The project’s payback is 1.5 years, and it has a weighted average cost of capital of 10 percent. What is the project’s modified internal rate of return (MIRR)? *

A. 10.00%

B. 19.65%

C. 21.54%

D. 23.82%

E. 14.75%

Answer 1

Ans= 5 - A) X,Y, Z should be selected.

- Wacc of project X = (weight of debt x cost of debt) + (weight of preferred stock x cost of preferred stock) + (weight of equity x cost of equity). weight of debt , equity and preferred stock = 33.33 (i.e 100 / 3). Cost of preferred stock= dividend / current price =8 / 65 = 0.1231 , cost of equity =( forcasted dividend / current price ) + g = ( 2 / 40) +0.13 = 0.18.

- Wacc of project X = (33.33 x 0.058) + (33.33 x 0.1231) + (33.33 x 0.18) = 0.1204 or 12.04%.

- NPV of project X = Pv of all cash inflow - cash outflow. PV of cash inflow = Cashflow / (1+rate)n

- PV of all cash inflow = 5000 / (1+0.1204)1 + 4000 / (1.1204)2 + 4000 / (1.1204)3 = 10,493.97

- NPV of project X = 10,493.97 - 10,000 = 493.97.

# Ans 5 = A) X, Y, Z should be selected as all the projects are independent projects that are having positive NPV. In this case, we won't select any project with 0 or negative NPV.

ANS 6= D) Only project Y should be selected, As NPV of project Y (i.e 678.98) is higher than the other projects and because the project is mutually exclusive therefore we would select project with highest NPV.

Ans= 7

- MIRR of project X =  (Terminal value of cashflow / PV of cashflow) 1 / n - 1 . Terminal value = Cashflow x (1+wacc)(n). N = time left until the end of project.

- Terminal value = 5000 x (1.1204)3 + 4000 x(1.1204)2 + 4000 x (1.1204)1 = 16,053.34

- MIRR = (16,053.34 / 10,493.97) 1/3 - 1 = 15.22 % or 0.1522.

# Ans 7 = A) X,Y,Z all project should be selected on the base of MIRR , as all project are independent project and having MIRR ( i.e 15.22% , 14.48% , 15% ) greater then firm's weight average cost of capital (i.e 12.04%).\

Ans 8 = C)  Only X should be select as MIRR for project X (i.e 15.22% ) is greater than MIRR of project Y and Z (i.e 14.48% , 15%) .AS all the projects are mutually exclusive therefore we will choose project with highest MIRR.