BUS4070_u06a2

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Capella University *

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4070

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Economics

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Jan 9, 2024

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4

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Valdez 1 Nafanua Valdez BUS4070- Foundations in Finance U06A2 May 20, 2022 10-1 AFTER TAX COST OF DEBT YTM= 10% Marginal Tax Rate= 25% The after-tax cost of debt = 10% * (1 – 25%) = 7.5% 10-2 COST OF PREFERRED STOCK Ppp: $57, Price of Stock Dp: $6.00, Dividend of Stock Rp: Cost of Preferred Stock Rp = Dp / Vp $57 = $6 / Rp Rp = 10.53% 10-16 COST OF COMMOM EQUITY EPS18 = EPS13 * (1+g) ^5 G = (EPS18 / EPS13) 1/5 – 1 = (6.50 / 4.42) 1/5-1 = 8.02% 10-20 WACC A) Before tax cost of debt (Rd) = 9% Tax Rate (T) = 40%
Valdez 2 After-Tax Cost of Debt = Rd* (1-T) 0.09 * (1-0.4) = 5.40% Growth Rate. EPS18 = EPS09 * (1+g) ^9 g = (EPS18 / EPS09) 1/9-1 = (7.80 / 3.90) 1/9-1 = 8.01% D1= EPS18*PR = $7.80 * 0.55 = $4.29 Current Stock Price (P0) = $65.00 Next Dividend (D1) = $4.29 (g) = 8.01% Rs = (D1 / P0) + g = (4.29 / 65) + 0.0801 = 14.61% B) Cost of Debt (Kd) Marginal Tax Rate = 25% Current Interest Rate = 9% Cost of debt After tax = current interest rate * (1-Tax rate) = 9% * (1-0.25) = 9% 0.75 = 6.75% Cost of Equity (Ke) Current market price of share = $65/share = (Dividend / Current market price) + Growth rate = ($4.29 / $65) + 7.9487% = 0.066 + 0.079487 = 0.145487 = 14.5487% WACC = Wd * Kd + We * Ke = 6.75% * 0.4 + 14.5487% * 0.6 = 2.7% + 8.72922% = 11.42922 = 11.43%
Valdez 3 12-7 SCENARIO ANALYSIS NPV Expected Return of the Project = Sum of (Prob. Of Outcome * NPV) = 0.05 * (-$70) + 0.20 * ($25) + 0.50 * ($12) + 0.2 * ($20) + 0.05 * ($30) = $3, 000, 000 Standard Deviation Variance = (-70-3)^2 * 0.05 + (-25-3)^2 * 0.20 + (12-3)^3 * 0.50 (20-3)^2 * 0.20 + (30- 3)^2 * 0.05 = $266.45m+ $156.80 + $40.50 + $57.80 + $36.45 = $558 Standard Deviation = Variance^0.5 = 558^0.5 = 23.62 million Coefficient of Variation Coefficient of Variation = Standard deviation / Expected NPV = $23,62 / $3 = 7.87 12-9 NEW PROJECT ANALYSIS A) The costs of investigating the machine's feasibility are a sunk cost that should be avoided when making decisions. B) Cost of milling machine = $143,000 Depreciation on machine in year 0 = $143,000 Tax Rate = 25% Increase in NOWC = $5,000 Project Cash Flow year 0 (CF0) = (Inflows) – (Outflows) = (Tax saving on depreciation) – (Cost + Increase in NOWC) = (depreciation (year 0)* tax rate) – ($143,000 + $5,000) = (143,000*0.25) – ($148,000) = ($35,750) – ($148,000) = -$112,250 C) 1 2 3 Annual Cash Savings $44,000 $44,000 $44,000 Less: Tax @ 35% (15,400 ) ($15,400) ($15,400) After-Tax Savings $28,600 $28,600 $28,600
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Valdez 4 Add: Depreciation Tax Savings Year 1: (108,000 + 12,500) *33% *35% Year 2: (108,000 + 12,500) *45%*35% Year 3: (108,000 + 12,500) *15%*35% $13,918 $18,979 $6,326 Net Cash Flow $42,518 $42,579 $34,926 D) Yes, I believe the machine purchased since the investment has a positive NPV. 13-5 OPTIMAL CAPITAL BUDGET A) Because each of these initiatives is unique and poses the same risk to the firm as its existing assets, the firm should accept all projects with an IRR>WACC. As a result, Projects A, B, C, D, and E should be chosen by the company. The optimal capital budget is the sum of the size for projects A, B, C, D, E = (750,000 + 1,250,000 + 1,250,000 + 750,000 = 5,250,000). B) If C and D are mutually exclusive, then Project D would be chosen because of its better NPV. Projects selected would be A, B, D & E. Then the optimal capital budget is $750,000 + $1,250,000 + $1,250,000 + $750,000 = $4,000,000. C) WACC of B, C, D, E is 12.5% D) WACC of project A = 12.5% + 2% = 14.5% WACC of project F&G = 12.5% - 2% = 10.5% Projects B, C, D, E, F, G will be selected since they have IRRs > their WACC Optimal Capital budget in this case = 1,250,000 + 1,250,000 + 1,250,000 + 750,000 + 750,000 + 750,000 = $6,000,000

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