Problem 1:
Three separate projects each have an initial cash outlay of $10,000. The cash flow for Peter's project is $4,000 per year for three years. The cash flow for Paul's Project is $2,000 in years 1 and 3 and $8,000 in year 3. Mary's Project has a cash flow of $10,000 in year 1, followed by $1,000 each year for years 2 and 3.
a. Use the payback method to calculate how many years it will take for each project to recoup the initial investment.
b. Which project would you consider most liquid?
Problem 2: Weighted Average Cost of Capital
Alvin C. York, the founder of York Corporation, thinks that the optimal capital structure of his company is 30 percent debt, 15 percent preferred stock, and the rest common equity. If the company is in the 40 percent tax bracket, compute its weighted average cost of capital given that:
a. YTM of its debt is 10 percent
b. New preferred stock will have a market value of $31, a dividend of $2 per share, and flotation costs of $1 per share.
c. Price of common stock is currently $100 per share, and new common stock can be issued at the same price with flotation costs of $4 per share. The expected dividend in one year is $4 per share, and the growth rate is 6 percent.
Assume the addition to retained earnings for the current period is zero.