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Texts: Cost of Capital and Capital Budgeting All returns are annual returns unless indicated otherwise. 1. The capital structure of a firm consists of debt and equity. The firm has 300,000 bonds outstanding that are selling at par value. The par value of the bonds is $1,000. Bonds with similar characteristics are yielding a before-tax return of 8%. The company also has 10,000,000 shares of common stock outstanding. The stock has a beta of 1.50 and sells for $90 a share. The annual rate of return on U.S. Treasury bills is 5% and the annual market rate of return is 11 percent. The firm’s tax rate is 25 percent. a) Find the company’s weighted average cost of capital (WACC or RWACC). b) The firm is considering a new project that is expected to generate annual operating cash flow (OCF) of $3,000,000 for five years. The project requires an initial investment (or initial cost) of $10,000,000. The assets used in the project will have a before-tax market value (salvage value) of $2,500,000 at the end of the project in year 5. Assume that the assets are fully depreciated over the five-year life of the project and the book value at the end of year 5 is zero. The project also requires an initial investment in net working capital of $800,000, which is fully recoverable at the end of the project (i.e., year 5). The project has the same risk as the overall firm. Find the net present value (NPV) of the project. Operating cash flow = After-tax net income + Depreciation

          Texts: Cost of Capital and Capital Budgeting

All returns are annual returns unless indicated otherwise.

1. The capital structure of a firm consists of debt and equity. The firm has 300,000 bonds outstanding that are selling at par value. The par value of the bonds is $1,000. Bonds with similar characteristics are yielding a before-tax return of 8%. The company also has 10,000,000 shares of common stock outstanding. The stock has a beta of 1.50 and sells for $90 a share. The annual rate of return on U.S. Treasury bills is 5% and the annual market rate of return is 11 percent. The firm’s tax rate is 25 percent.

a) Find the company’s weighted average cost of capital (WACC or RWACC).
b) The firm is considering a new project that is expected to generate annual operating cash flow (OCF) of $3,000,000 for five years*. The project requires an initial investment (or initial cost) of $10,000,000. The assets used in the project will have a before-tax market value (salvage value) of $2,500,000 at the end of the project in year 5. Assume that the assets are fully depreciated over the five-year life of the project and the book value at the end of year 5 is zero. The project also requires an initial investment in net working capital of $800,000, which is fully recoverable at the end of the project (i.e., year 5). The project has the same risk as the overall firm. Find the net present value (NPV) of the project.

*Operating cash flow = After-tax net income + Depreciation

Added by Sara J.

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