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The Cost of Capital And The Basics of Capital B...

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The Cost of Capital And The Basics of Capital Budgeting: Evaluating Cash Flows Problem 1 You are employed by ABC Inc. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT. Assets Current assets $30,000,000 Net plant, property, and equipment $100,000,000 Total Assets $130,000,000 Liabilities and Equity Accounts payable $10,000,000 Accruals $10,000,000 Current liabilities $20,000,000 Long term debt (40,000 bonds, $1,000 face value) $40,000,000 Total liabilities $60,000,000 Preferred Stock (100,000 shares, $100 face value) $10,000,000 Common Stock (10,000,000 shares) $30,000,000 Retained Earnings $30,000,000 Total shareholders equity $70,000,000 Total liabilities and shareholders equity $130,000,000 You check The Wall Street Journal and see that ABC stock is currently selling for $10.00 per share and that ABC bonds are selling for $1100.0 per bond. These bonds have a 7 percent coupon rate, with semi-annual payments. The bonds mature in twelve years. The preferred stock has an unlimited life and pays an 5 percent annual coupon. The preferred stock sells for $95. The beta for your company is approximately equal to 2. The yield on a 20-year Treasury bond is 4.0 percent. The expected return on the stock market is 8.0 percent. ABC is in the 40 percent tax bracket. 2. Davis Corporation is faced with two independent investment opportunities. The corporation has an investment policy which requires acceptable projects to recover all costs within 3 years. The cost of capital is 10 percent. The cash flows for the two projects are: Project A Project B Year Cash Flow Cash Flow 0 -$120,000 -$90,000 1 42,000 30,000 2 43,000 30,000 3 44,000 30,000 4 45,000 30,000 5 46,000 30,000 Which investment project(s) does the company invest in using the: 1) Payback period rule 2) Discounted payback period rule 3) NPV 4) IRR 3. XYZ Corporation is faced with two mutually exclusive investment opportunities. The cost of capital is 12 percent. The cash flows for the two projects are: Project A Project B Year Cash Flow Cash Flow 0 -$140,000 -$100,000 1 60,000 30,000 2 60,000 30,000 3 60,000 30,000 4 30,000 5 30,000 6 30,000 Which investment project should the company invest in using the: 1. Equivalent annual annuity approach 2. The replacement approach

 

Paper#6958 | Written in 18-Jul-2015

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