1) The common stock of Buildwell Construction has a beta of 0.90. The T-bill rate is 4% and the market risk premium is estimated at 8%. Buildwell's capital structure is 30% debt, paying a 5% interest rate and 70% equity. Buildwell pays tax at 40%. What is Buildwell's cost of equity capital? Its WACC? If the company is evaluating a project that will generate a cash flow of $100,000 for 8 years, what is the most Buildwell should be willing to pay to initiate the project?
2) Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with a face value of $20 million, a maturity of 10 years and a yield to maturity of 10%. The coupons are paid annually. The other bond has a maturity of 15 years, with coupons also paid annually and a coupon rate of 10%. The face value of the issue is $25 million and the issue sells for 94% of par value. The firm's tax rate is 35%. What is the before-tax cost of debt? What is the after-tax cost of debt?
3) Titan Mining Corporation has 14 million shares of common stock outstanding, 700,000 shares of 5 percent preferred stock outstanding, and 200,000 6.5 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $36 per share and has a beta of 1.3, the preferred stock currently sells for $83 per share, and the bonds have 14 years to maturity and sell for 93 percent of par. The market risk premium is 8.5 percent, T-bills are yielding 3 percent, and Titan Mining's tax rate is 35 percent.
a) What is the firm's market value capital structure?
b) If Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows?
4) Consider a project to supply 100 million postage stamps per year to U.S. postal service for the next 5 years. You have an idle parcel of land available that cost $2,400,000 five years ago; if the land were sold today, it would net you $2,700,000 after-tax. The land can be sold for $3,200,000 after taxes in five years. You will need to install $4,100,000 in new manufacturing plant and equipment to actually produce stamps; this plant and equipment will be depreciated straight-line to zero over the project's five-year life. The equipment can be sold for $540,000 at the end of the project. You will also need $600,000 in initial net working capital for the project and an additional $50,000 every year thereafter. Your production costs are $0.5 per stamp, and you have fixed costs of $950,000 per year. If the tax rate is 34 percent and your required return on the project is 12 percent, what bid price should you submit on the contract?
5) Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,900,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are $170,000 per year. Machine B costs $5,100,000 and will last for nine years. Variable costs for this machine are 30 percent and fixed cost are $130,000 per year. The sales for each machine will be $10 million per year. The required return is 10 percent and the tax rate is 35 percent. Both machines will be depreciated on a straight - line basis. If the company plants to replace the machine when it wears out on a perpetual basis, which machine should you choose?
6)Compact fluorescent lamps (CFLs) have become more popular in recent years, but do they make financial sense? Suppose a typical 60-watt incandescent light bulb costs $0.50 and lasts 1,000 hours. A 15-watt CFL, which provides the same light, costs $3.5 and lasts for 12,000 hours. A kilowatt-hour of electricity costs $0.101, which is about the national average. A kilowatt-hour is 1,000 watts for 1 hour. If you require a 10 percent return and use a light fixture 500 hours per year, what is the equivalent annual cost of each light bulb?
7) The previous problem suggests that using CFLs instead of incandescent bulbs is a no-brainer. However, electricity costs actually vary quite a bit depending on location and user type (you can get information on your rates from your local power company). An industrial user in West Virginia might pay $0.04 per kilowatt-hour whereas a residential user in Hawaii might pay $0.25. What's the break-even cost per kilowatt-hour in the previous problem?