Problem 1: (Calculating the WACC) The required return on debt is 8%, the required return on equity is 14%, and the marginal tax rate is 40%. If the firm is financed 70% equity and 30% debt, what is the weighted average cost of capital?
Problem 2: (Finding NPVs with differing project risks) Assume the expected return on the market portfolio is 15% and the riskless return is 9%. Also assume that all of the projects listed here are perpetuities with annual cash flows (in $) and betas as indicated. None of the projects requires or precludes any of the other projects, and each project costs $2,000.
a. What is the NPV of each project?
b. Which projects should the firm undertake?
| PROJECT |
A |
B |
C |
D |
E |
F |
| Annual cash flow |
310 |
500 |
435 |
270 |
385 |
450 |
| Beta |
1.00 |
2.25 |
2.22 |
0.65 |
1.37 |
2.36 |
Problem 3: (Estimating the WACC) Fuerst Cola has 10,000 bonds and 400,000 shares outstanding. The bonds have a 10% annual coupon, $1,000 face value, $1,050 market value, and 10-year maturity. The beta on the stock is 1.30 and its price per share is $40. The riskless return is 6%, the expected market return is 14%, and Fuerst Cola’s tax rate is 40%.
a. What is the after-tax cost of debt financing?
b. What is the after-tax cost of equity financing?
c. What is the WACC?