1. As a newly-hired financial analyst with Traid Winds, Incorporated, you have been asked to calculate the firm's weighted average cost of capital (WACC). (7.5 points total)
a) A 14-year bond with an 8 percent semiannual coupon has a par value of $1,000. The price of the bond today is $1,075. What is the company's marginal cost of debt, rd?
b) The firm's preferred stock has a par value of $100 per share, and pays a 5.6% annual dividend. If the preferred stock's current price is $80, what is the firm's marginal cost of preferred stock, rp?
c) The company is expected to pay a year-end common stock dividend (D1) of $2.10 per share, and the firm has projected a constant growth rate of 5%. The current stock price is $21.875 per share. The firm will need to issue new shares to finance its future projects. If flotation costs are 20 percent, what is the marginal cost of equity, re, for the firm?
d) Assuming a target capital structure of 40% debt, 10% preferred stock, and 50% common stock, and a 35% tax rate, what is the firm's cost of capital?
2. Traid Winds is planning to introduce a new hedge cutter. The product will be manufactured in an unused facility that is fully depreciated. The project will be operational for only the next four years. Following are the details of the project:
• The project requires the purchase of new equipment at an invoice cost of $28,500,000. It will cost an additional $1,500,000 to install the equipment.
• The capital investment will be depreciated using a 5-year MACRS schedule. The depreciation schedule is as follows: 20%; 32%; 19%; 12%; 11%; and 6%.
• If the project is undertaken, the company will need to increase inventory by $1,200,000. Accounts receivable will increase by $800,000, and accounts payable by $500,000.
• To project demand for this new product, the company has spent $3,200,000 in focus groups and pre-market testing.
• The project is expected to generate sales of 200,000 units in the first year; 265,000 units in each the second and third years, and 300,000 in the fourth year. The sales price per unit will be $75.
• Variable costs are expected to be 45 percent of revenue. Other operating costs (excluding depreciation) will equal $800,000 a year.
• To undertake the project, the firm will need to borrow $14,000,000 at a rate equal to the marginal cost of debt.
• The equipment is expected to have a salvage value (before-tax) of $7,500,000.
• The firm's tax rate is 35%.
• The proposed project has average risk, so the firm's WACC as calculated in Question 1 would be used to evaluate the project.
a. What are the cash flows associated with the project for each year?
b. What is the NPV of the project?
c. What is the internal rate of return on the project?
d. Would you accept the project? Why or why not?