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:

5) What is the WACC?

6) What is the IRR?

7) What is the Payback Period?

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

	after tax cost of bank loan	interest rate*(1-tax rate)	10%*(1-.20)	8.0%
	before tax cost of bond =Using rate function in MS excel	rate(nper,pmt,pv,fv,type) nper = 4*5 =20 pmt = 1000*9%*1/4 = -22.5 pv = 1070-20 =1050 fv=-1000 type =0	RATE(20,-22.5,1050,-1000,0)	1.95%
	after tax annual cost of bond	(1.95*4)*(1-.2)	6.24
	cost of preferred stock = preferred dividend/(selling price-fotation cost)	15/(210-10)	7.50%
	cost of common stock = risk free rate+(market return-risk free rate)*beta	5+(15-5)*1.5	20%
	WACC
	source	value	weight	component cost	weight*component cost
	bank loan	100	0.2	8.0%	0.016
	bonds	180	0.36	6.24%	0.022464
	preferred stock	20	0.04	7.50%	0.003
	common stock	200	0.4	20%	0.08
	total	500
WACC	WACC = sum of weight*component cost				12.15%
	Year
	0	-1500
	1	-100
	2	1000
	3	700
IRR	IRR =Using IRR function in MS excel	IRR(F2786:F2789)	2.62%
NPV	Year	cash flow	present value factor at 12.15% =1/(1.1215)^n   n =1,2,3	present value of cash flow = cash flow*present value factor
	0	-1500	1	-1500
	1	-100	0.891662951	-89.16629514
	2	1000	0.795062819	795.0628189
	3	700	0.70892806	496.2496418
	net present value =sum of present value of cash flow			-297.85
PayBack period	Year	cash flow	cumulative cash flow
	0	-1500
	1	-100	-1600
	2	1000	-600	amount to be recovered in year 3
	3	700
	payback period = year before final year of recovery+(amount to be recovered/cash flow of the final year of recovery)	2+(600/700)	2.86
	Fina should not accept the project as IRR is less than the WACC and NPV is negative. ProJect can be accpeted using payback method as Payback period is less than the life of the project.
value of stock	value of stock = expected dividend/(cost of common stock-growth rate)	4/(20%-6%)	28.57