A firm has the following capital structure: Bonds with market value of $3,000,000 Preferred Stock with...

A firm has the following capital structure:

Bonds with market value of $3,000,000
Preferred Stock with a market value of $2,000,000
Common stock, of which 400,000 shares is outstanding. Presently, each common stock is selling at $30 per share

The preferred stock price per share is $60 and pays a $5 dividend. Common stock shares sell for $30 and pay a $2 dividend. Dividends for common stock are expected to grow by 3%. Bond price is $950, and the bond coupon rate is 6.5%. The bonds mature in 7 years.

The firm’s tax rate is 38%. The company has $3,500,000 in sales, and expenses of $1,200,000. The initial investment of $5,500,000 will be depreciated straight-line over 10 years. The project is expected to last 10 years.

What is the firm’s Weighted Average Cost of Capital (WACC)?

_____________________ (Chapter 13)

What is the firm’s Operating Cash Flow (OCF)?

______________________ (Chapter 9)

Using the WACC is the NPV, using the WACC (use the answer from question 1 above), and OCF (use the answer from question 2 above)?

______________________ (Chapter 8)

Based on your answer to question #3, would you accept or reject the project? Explain why?

_______________________________________________________Chapter 8

Solutions

Expert Solution

1]	Before tax cost of debt = YTM.
	YTM using a calculator = 7.44%
	After tax cost of debt = 7.44%*(1-38%) =	4.61%
	Cost of preferred stock = 5/60 =	8.33%
	Cost of common stock = 2*1.03/30+0.03 =	9.87%
	CALCULATION OF WACC:
	Component	Market Value	Weight	Component Cost	WACC
	Debt	$ 30,00,000	17.65%	4.61%	0.81%
	Preferred stock	$ 20,00,000	11.76%	8.33%	0.98%
	Common stock [400000*30]	$ 1,20,00,000	70.59%	9.87%	6.96%
	Total	$ 1,70,00,000	100.00%		8.76%
	WACC = 8.76%
2]	Sales	$ 35,00,000
	Expenses	$ 12,00,000
	Depreciation	$ 5,50,000
	EBIT	$ 17,50,000
	Tax at 38%	$ 6,65,000
	NOPAT	$ 10,85,000
	Add: Depreciation	$ 5,50,000
	Operating cash flow	$ 16,35,000
3]	NPV = -5500000+1635000(1.0876^10-1)/(0.08761.0876^10) =	$ 51,04,632
4]	The project can be accepted as the NPV is positive.

jeff jeffy answered 1 year ago

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