Question

1) A project has the following information. Price is $62 per unit, variable cost is $41 per unit, fixed costs is $15500, required return is 12%, initial investment $24000, project life is 4 years. Ignoring taxes,

1. What’s accounting breakeven
2. What’s cash breakeven
3. What’s financial breakeven?
4. What’s DOL at financial breakeven level?

2) A stock has a beta of 1.05. The expected return of the market is 10%, and risk free rate is 3.8%.

What’s the expected return of the stock?

3) Holdup bank has an issue of preferred stock with a 4.25 stated dividend and its selling for $92 per share. What’s the cost of its preferred?

4) Molineux corp. has market value of equity at $20 billion, and its debt book value is $4 billion. Its cost of equity is 12%, and pretax cost of debt of 7%. Its tax rate is 35%.

1. What’s the company’s capital structure?
2. What’s the after tax cost of debt?
3. What’s the company’s WACC?

Answer 1

1.
Calculation of accounting breakeven
Accounting breakeven = (Fixed costs+Depreciation)/(Contribution margin per unit)
Depreciation = 24000/4	6000
Contribution margin = (62-41)	21
Accounting breakeven = (15500+6000)/21
Accounting breakeven	1023.809524
The accounting breakeven is 1024 units
Calculation of cash breakeven
Cash breakeven = Fixed costs/(Contribution margin per unit)
Cash breakeven = 15500/21
Cash breakeven	738.10
The cash breakeven is 739 units
Calculation of financial breakeven
Calculation of operating cash flow from the project
Present value = Operating cash flow*(1-(1+r)^-n)/r
24000 = Operating cash flow*(1-(1.12^-4))/0.12
24000/3.037349 = Operating cash flow
Operating cash flow	$7,901.63
Financial breakeven =(Fixed costs + Operating cash flow)/Contribution margin per unit
Financial breakeven	(15500+7901.63)/21
Financial breakeven	1114.36
The financial breakeven is 1,115 units
Degree of financial leverage = 1+(Fixed costs/Operating cash flow)
Degree of financial leverage	1+(15500/7901.63)
Degree of financial leverage	2.96
The degree of financial leverage is 2.96
2.
Using the CAPM model, the expected return of the stock can be calculated
Expected return = Risk free rate + Beta*(Market return - risk free rate)
Expected return	0.038 + (1.05*(0.10-0.038))
Expected return	0.1031
The expected return of the stock is 10.31%
3.
Cost of preferred stock = Dividend/Price
Cost of preferred stock	4.25/92
Cost of preferred stock	4.62%
The cost of preferred stock is 4.62%
4.
Market value of equity	$20	billion
Book value of debt	$4	billion
Total value of company	$24	billion
% of equity = 20/24	83.33%
% of debt = 4/24	16.67%
Thus the capital structure of company is equity 83.33% and debt 16.67%
After tax cost of debt = 0.07*(1-0.35)
After tax cost of debt	4.55%
The after tax cost of debt is 4.55%
WACC = (Cost of equity*Weight of equity)+(After tax cost of debt*Weight of debt)
WACC = (0.12*0.83333)+(0.0455*0.16666)
WACC	10.76%
The WACC of company is 10.76%