Question

24. Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company’s outstanding bonds is 7.75%, its tax rate is 25%, the next expected dividend is $0.65 a share, the dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is $14.00 per share, the flotation cost for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?

a. 7.98%

b. 8.75%

c. 9.51%

d. 10.12%

27. Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

WACC:     10.00%

Year	0	1	2	3	4
Cash flows	-$1,300	$525	$485	$445	$405

a. 3.42 years

b. 2.62 years

c. 3.32 years

d. 2.75 years

Answer 1

24.

After Tax Cost of Debt =  yield on the company’s outstanding bonds * (1-tax rate)

= 7.75%*(1- 25%)

= 5.8125%

Cost of Equity = Expected Dividend / [Price*(1-Flotation Cost)] + Growth Rate

= 0.65/[14  *(1-10%)] + 6%

= 0.65/12.6+ 6%

= 11.15873016%

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= (5.8125%*45%)+(11.15873016%*55%)

= 8.75%

Answer = b. 8.75%

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27.

Discounted Payback Period =

( Last Year with a Negative Cumulative Cash Flow ) + [( Absolute Value of negative Cumulative Cash Flow in that year)/ Total Present Cash Flow in the following year)]

= 3 +(87.57/276.62)

=3.32 years

Answer = c. 3.32 years

Note:

	Cash Flow	Discounting Factor ( 10%)	Present Value (Cash Flow * Discounting Factor)	Cumulative Cash Flow (Present Value of Current Year+ Cumulative Cash Flow of Previous Year)
0	-1,300	1	-1,300.00	-1,300.00
1	525	0.9091	477.27	-822.73
2	485	0.8264	400.83	-421.90
3	445	0.7513	334.34	-87.57
4	405	0.6830	276.62	189.05