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Q4. Stag corp has a capital structure which is based on 50% common stock, 20% preferred...

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 ?

Solutions

Expert Solution

(a)-Weighted Average Cost of Capital (WACC) of the firm

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [10.00%(1 – 0.40) x 0.30] + [8.00% x 0.20] + [14.00% x 0.50]

= [6.00 x 0.30] + [8.00% x 0.20] + [14.00% x 0.50]

= 1.80% + 1.60% + 7.00%

= 10.40%

(b)-Net Present Value of the Project

Year

Annual cash flows ($)

Present Value Factor (PVF) at 10.40%

Present Value of annual cash flows ($)

[Annual cash flow x PVF]

1

66,000

0.9057971

59,782.61

2

3,20,000

0.8204684

2,62,549.88

3

1,33,000

0.7431779

98,842.66

TOTAL

4,21,175.15

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $421,175.15 - $280,000

= $141,175.15

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 1 year ago
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