Question

 

Q2. What is the EAC of two projects: project A, which costs $150 and is expected to last two years, and project B, which costs $190 and is expected to last three years? The cost of capital is 12%. (1 mark)

Answer:

Q3. A company pays annual dividends of $10.40 with no possibility of it changing in the next several years. If the firm’s stock is currently selling at $80, what is the required rate of return? (1 mark)

Answer:

Q4. Stag corp has a capital structure which is based on 50% common stock, 20% preferred stock and 30% debt. The cost of common stock is 14%, the cost of preferred stock is 8% and the pre-tax cost of debt is 10%. The firm's tax rate is 40%. (1 mark)

1. Calculate the WACC of the firm.
2. The firm is considering a project that is equally as risky as the firm's current operations. This project has initial costs of $280,000 and annual cash inflows of $66,000, $320,000, and $133,000 over the next three years, respectively. What is the net present value of this project ?

Answer 1

EAC =NPV / PV of Annuity Factor

NPV=$150 for A and $190 for B

PV of Annuity Factor =(1-(1/(1+r)^t))/r r here is the cost of capital and t is the time period

r= 12% and t = 2 for A and T = 3 for B

PVAF= 1-(1/1+.12)^2))/.12=$1.69 for A

For B =1-(1/1+.12)^3))/.12=$2.4 for B

Hence EAC for A = $150/$1.69 =$88.75

3) Stock value = Dividend /k-g where k is RRR and g is growth rate here Dividend =$10.4 and Stock value = $80 g=0 solving for k 80=10.4/k kor RRR = 10.4/80 ie .13 ie 13%

4)WACC = Sum of ( Weight of the component in Capital Structure)*( Cost of the component in Capital Structure)

here Cost of common stock is given as 14% and cost of preffered Stock is given as 8% and after tax cost of debt=.1(1-.4)=6%(cost of Debt (1-tax rate)

Wacc = .5*.14+.2*.08+.3*.06=.07+.016+.018=.104= 10.4%

5) Assuming discount rate is 12% NPV= PV of Cash inflow - initial outflow

PV of Year 1 inflow = $66000*.8929= $58931.4

PV of Year 2 inflow = $320000*.79722=$ $255104

Pv of Year 3 inflow =$133000*.7118=$94669.4

NPV =58931.4+255104+94669.4-280000=$128704.8