Question

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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:

  1. Bonds with market value of $3,000,000
  2. Preferred Stock with a market value of $2,000,000
  3. 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.

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

_____________________ (Chapter 13)

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

______________________ (Chapter 9)

  1. 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)

  1. 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)/(0.0876*1.0876^10) = $      51,04,632
4] The project can be accepted as the NPV is positive.

jeff jeffy answered 2 years ago
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