Question 1: A company has a capital structure composed by 20% Debt and 80% Equity. The cost of the debt is 5% per year while the cost of equity is 15% per year.
The company is considering two different projects. The cash flows of the two projects are reported in the table below.
|
Time
|
Project A
|
Project B
|
|
0
|
($120,000)
|
($150,000)
|
|
1
|
$25,000
|
$38,000
|
|
2
|
$35,000
|
$38,000
|
|
3
|
$50,000
|
$50,000
|
|
4
|
$50,000
|
$50,000
|
|
5
|
$35,000
|
$50,000
|
a) Compute the NPV of each project.
b) Which project the company should accept? Explain.
Question 2: The company LL has a capital structure composed by 30% of debt and 70% of equity and is planning to invest in a new industry.
Following the standard technique in Corporate Finance, the financial manager of the company finds that the two main pure plays of the new industry have the following characteristics.
|
|
Company PP
|
Company CC
|
|
Stock Beta
|
0.80
|
1.00
|
|
Fraction of Debt
|
0.25
|
0.40
|
|
Fraction of Equity
|
0.75
|
0.60
|
Assume the expected return on the market is 8% while the risk free rate of interest is 3% per annum. The company pays a 4.5% rate for the debt.
Compute the WACC of this project. [Hint: Carefully explain each step you need to compute the WACC.]
Question 3: Assume you are considering and investment in a project that requires an initial outlay of $225,000 and will produce after-tax cash flows of $35,000 per year for the next 15 yrs. Your firm uses 50% debt and 50% equity in its financing. The after-tax cost of the debt and equity are 9% and 15% respectively.
a) What is the project WACC?
b) What is the project NPV? Should the project be accepted?