Problem 1:
Great Expectations, a wedding and maternity clothing manufacturer, has a cost of equity of 16% and a cost of preferred stock of 14%.
Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. Assume that he most recent balance sheet shown here reflects the optimal capital structure. Calculate Great Expectations' after-tax WACC.
| Great Expectations Balance Sheet |
|
| Dec. 31, 2009 |
|
| Assets |
|
Liabilities and Equity |
| Cash |
$50,000 |
|
|
|
| Accounts Receivable |
$90,000 |
|
Long-Term Debt |
$600,000 |
| Inventories |
$300,000 |
|
Preferred Stock |
$250,000 |
| Plant and Equipment, net |
$810,000 |
|
Common Stock |
$400,000 |
| Total Assets |
$1,250,000 |
|
Total Liabilities and Equity |
$1,250,000 |
Babe's Dog Obedience School, Inc., wants to maintain its current capital structure of 50% common equity, 10% preferred stock, and 40% debt. Its cost of common equity is 13%, and the cost of preferred stock is 12%. The bank's effective annual interest rate is 11% for amounts borrowed that are less than or equal to $1 million and 13% for amounts between $1 million and $2 million. If more than $2 million is borrowed, the effective annual interest rate charged is 15%. Babe's tax rate is 40%. The firm expects to realize $2,750,000 in net income this year after preferred dividends have been paid.
a. Calculate the MCC if $900,000 is needed for an upcoming project.
b. Calculate the MCC if $3,000,000 is needed for the project instead.
c. If a different project is adopted and $5,005,000 is needed for it, what is the MCC?
Calculate the expected rates of return for the low-average-and high risk stocks:
a. Risk-free rate=4.5%
b. Market risk premium= 12.5%
c. Low-risk beta=.5
d. Average-risk beta=1.0
e. High-risk beta=1.6