Question

FINA Inc. considers a project with the following information:

Initial Outlay: 1,500

After-tax cash flows:

Year 1: -$100

Year 2:  $1000

Year 3: $700

FINA’s assets are $500 million, financed through bank loans, bonds, preferred stocks, and common stocks. The amounts are as follows:

Bank loans: $ 100 million borrowed at 10%

Bonds: $180 million, paying 9% coupon with quarterly payments, and maturity of 5 years. FINA sold its $1,000 par-value bonds for $1,070 and had to incur $20 flotation cost per bond.

Preferred Stocks: $20 million, paying $15 dividends per share. FINA sold its preferred shares for $210 and had to incur a $10/share flotation cost.

Common Stocks: $200 million, the beta of FINA stocks is 1.5, the 90 day Treasury yield is 5%, and the return on the market portfolio is 15 %. FINA is subject to a 20% tax rate.

Assuming the company uses WACC to compute the present value of the future cash flows, please find the following:

8) What is the NPV?

9) Should FINA accept the project? According to IRR? According to the Payback period? According to NPV?

10) FINA is expected to pay a $4 per share common stock dividend at the end of this year. The dividends are expected to grow at 6% per year forever. How much should be the value of FINA’s shares?

Answer 1

WACC of the FINA INC.:-

Bank loan cost = interest rate * ( 1 - tax rate) = 0.10 * ( 1 - 0.20) = 8%

Cost of debt before tax =[ i + ( D - NP) / n ] / ( D + NP)/2

Here I = annual interest payment =

D = Face value =

NP = Net proceeds =

Cost of debt before tax =[ i + ( D - NP) / n ] / ( D + NP)/2

Here I = annual interest payment = 1000 * 9% = 90

D = Face value = 1000

NP = Net proceeds = 1070 -20 = 1050 n= 5 years

cost of debt before tax = [ 90 + (1000 -1050) / 5 ] / ( 1000+1050) /2 = [ 90 -10] / 1025 = 0.07804878

Cost of debt after tax = cost of debt before tax * ( 1 - tax rate) = 0.07804878 * ( 1- 0.20 ) = 0.0624390

cost of debt after tax = 6.24%

Cost of preferred stock:-

Cost of preferred stock = Dividend / [market price per share - flotation cost ] = 15 / (210 - 10) = 15 / 200 = 7.5%

Cost of common stock :-

Cost of common stock using capm = Rf + Beta ( Rm - Rf)

= 5% + 1.5 * ( 15% - 5%)

cost of common stock = 20%

WACC:-

WACC = Cost of loan after tax * weight of loan + cost of debt after tax * weight of debt + cost of preferred stock * weight of preferred stock + cost of equity * weight of equity

WACC = 8% * 100/500 + 6.24% * 180 / 500 + 7.5% * 20 /500 + 20% * 200/500 = 12.1464%

WACC = 12.15%

8) NPV:-

NPV = -1500 + (-100) / (1.1215) + 1000 / (1.1215)2 + 700 / (1.1215)3

NPV = -297.85

9) According IRR:-

At IRR, NPV = 0

here WACC NPV = -297.85

Confirmely IRR is below the WACC,.

So the project would be Rejected According IRR.

According To Payback period :-

Particulars	cash flows	cumulative cash flows
0	-1500	-1500
1	-100	-1600
2	1000	-600
3	700	100

Payback period = 2 + 600/700 = 2.86 years

Here Payback period is less than life of the project.

So, the project should be accepted,according to payback period.

According NPV :-

the best discounting rate for discounting cash flows is WACC

At WACC, NPV is negative that is -297.85

10) Expected dividend (D1)= $ 4 per share

Growth rate = 6%

Ke = 20%

Market price = D1 / (Ke - g) = 4 / ( 0.20 - 0.06) = $ 28.57