Question

FINA Company’s assets are $750 million, financed through bank loans, bonds, preferred stocks, and common stocks. The amounts are as follows:

Bank loans: $ 100 million borrowed at 3%

Bonds: $280 million, paying 8% coupon with semi-annual payments, and maturity of 10 years. FINA sold its $1,000 par-value bonds for $970 and had to incur $20 flotation cost per bond.

Preferred Stocks: $120 million, paying $15 dividends per share. FINA sold its preferred shares for $220 and had to incur $20 per share flotation cost.

Common Stocks: $250 million, beta is 3.20, the risk-free rate is 5 percent, and the market rate is 10%.

FINA is considering a new project that will last for five years with the following after-tax cash flows:

Cost of the project: $700,000

Year	Cash flow
1	148,000
2	148,000
3	148,000
4	148,000
5	253,000

1. If FINA is subject to a 20% tax rate, what is the WACC for FINA?
2. The company uses WACC to compute the NPV. What is the NPV and IRR of the project? Should FINA accept the project according to IRR and NPV?

Answer 1

Part A) WACC

Weight of bank loan= 100 / 750 = 0.1333

Weight of Bonds= 280 / 750 = 0.3733

Weight of preferred shares = 120 / 750 = 0.16

Weight of common stock = 250 / 750 = 0.3333

Cost of preferred stock = dividend / price - floatation cost

= 15 / 220 - 20

= 15 / 200

= 0.075 or 7.5%

Common stock = risk free rate + beta (market return - risk free rate)

= 5% + 3.20 (10% - 5%)

= 5% + 3.20 (5%)

= 5% + 16%

= 21%

After tax cost of bank loan= 3% (1 - 0.20)

= 3% (0.8)

= 2.4%

Cost of debt

Using financial calculator to calculate the cost of debt

Inputs: N= 10 × 2 = 20 (semiannual)

Pv= 970 - 20 = -950

Pmt= 8% / 2 × 1,000 = 40

Fv= 1,000

I/y= compute

We get, ytm of the bond as 4.38% × 2 = 8.76%

After tax cost of debt = 8.76% (1-0.20)

= 8.76% (0.8)

= 7.01%

WACC= weight of bank loan × after tax cost of bank loan + weight of bond × after tax cost of bond + weight of preferred stock × cost of preferred stock + weight of common shares × cost of common shares

= 0.1333 × 2.4% + 0.3733 × 7.01% + 0.16 × 7.5% + 0.3333 × 21%

= 0.32% + 2.62% + 1.2% + 7%

= 11.14%

Part B) NPV

Using financial calculator to calculate the Npv

Inputs: C0= -700,000

C1= 148,000. Frequency= 4

C2= 253,000. Frequency= 1

I = 11.14%

Npv= compute

We get, NPV as -$93,007.24

Paet C) IRR

Using financial calculator to calculate the IRR

Inputs: C0= -700,000

C1= 148,000. Frequency= 4

C2= 253,000. Frequency= 1

Irr= compute

We get, the IRR as 6.092%

As the NPV of the project is negative and IRR is less than the WACC , FINA should not accept the project.