FRA Inc. will finance a new 2-year investment project that costs €1,000,000 with both equity and debt capital. Equity will cover 40% of the cost, while debt will be equally split over a bank loan (30%) and a bond issue (30%). Details on how the project is financed are as follows: A. The bank loan will have a 2-year maturity, and the annual interest rate will be 6%. The loan will be paid-off in 24 monthly equal installments. Demonstrate analytically the loan amortization schedule for all 24 months. B. The corporate bonds will have a maturity of 2 years, face value of €1,000, 15% coupon rate and annual interest payments. Their price at issuance will be €1,186. The current stock price of FRA Inc. is €10. The company just paid a dividend of €1 per share and the annual dividend growth rate is 2%, constant, and estimated to stay at this level for the foreseeable future. Use the above information to calculate the annual

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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FRA Inc. will finance a new 2-year investment project that costs €1,000,000 with both equity and debt capital. Equity will cover 40% of the cost, while debt will be equally split over a bank loan (30%) and a bond issue (30%). Details on how the project is financed are as follows: A. The bank loan will have a 2-year maturity, and the annual interest rate will be 6%. The loan will be paid-off in 24 monthly equal installments. Demonstrate analytically the loan amortization schedule for all 24 months. B. The corporate bonds will have a maturity of 2 years, face value of €1,000, 15% coupon rate and annual interest payments. Their price at issuance will be €1,186. The current stock price of FRA Inc. is €10. The company just paid a dividend of €1 per share and the annual dividend growth rate is 2%, constant, and estimated to stay at this level for the foreseeable future. Use the above information to calculate the annual weighted average cost of capital of this company. Assume the following:

  • The new investment has the same level of risk as any other investment that FRA Inc. has already undertaken.
  • FRA Inc. uses the same capital structure in all its capital expenditure projects.
  • The corporate tax rate is 40%.
  • There are no flotation costs (issuance costs) for any source of capital.

 

 What are the main assumptions that should hold so that we can use the company WACC to assess individual investment projects? Describe what might happen and what we should do if these assumptions would not hold. 

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