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Consider an all-equity financed firm that has an opportunity to invest in one of two mutually-exclusive projects. Each project requires an investment today of £400 million. In one year’s time, project A pays £520 million with probability 80% and £200 million with probability 20%. Next year, project B pays £600 million with probability 20% and £200 million with probability 80%. After these cash flows, the firm will be shut down. There are no taxes, depreciation, or any other benefits or costs. To implement one of these projects, the firm must raise debt financing. Note that the managers of the firm will act in the interests of the equity holders and that project choice occurs after debt financing is granted, so debtholders cannot control the choice of project after financing. However, debtholders can rationally anticipate the actions of managers. When answering this question, state any additional assumptions you may need to make. Show your calculations. For parts (a) and (b), assume all cash-flows are discounted at 0%. a. Compute the NPVs of the two projects. Which project is better? b. Show that the firm will be able to raise £400 million today via the issue of debt. Compute the terms of the debt (i.e. the face value) required by lenders. For parts (c) and (d) assume, instead, that all cash flows are discounted at 12%. c. Recompute the NPVs of the two projects. Which project is better now? d. Show that the firm will not now be able to raise £400 million today via the issue of debt. Explain why this is so. Be precise; show your steps and explain your reasoning.

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Your firm has decided to spin off Android01 and Processor01 as a separate firm. The owners of the new firm will be equity holders and debt holders. After speaking with potential investors, investment banks have identified two possible capital structures (structure of equity and debt ownership):

Debt holders receive debt that pays them coupons of $2 million a year, and $30 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 4 percent. Equity holders receive expected dividends of $3 million starting from year 5, and growing at a rate of 4 percent per year (a growing perpetuity). They price the equity using a discount rate of 7.5 percent.

Debt holders receive debt that pays them coupons of $1 million a year, and $12 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 3.5 percent. Equity holders receive expected dividends of $3.9 million starting from year 5, and growing at a rate of 4.5 percent per year (a growing perpetuity). They price the equity using a discount rate of 7 percent.

Your firm receives all the proceeds from the sale debt and equity.

Prepare a Capital Budgeting and Cost of Capital report that answers the following Question 13.

Question 13: Which particular capital structure should be chosen for the spin-off?

Before starting your calculations, review the following materials:

cost of capital and choice of financing

equity, debt, and preferred stock

Submit your Capital Budgeting and Cost of Capital Report to the dropbox below.

Please answer ALL of these questions. It would really help me out! Thanks!

1. MV corporation has debt with Market value of $100 million, common equity with a book value of $100 million, and preferred stock woth $20 million outstanding. It's common equity trades at $50 per share, and the firm has 6 million shares outstanding. What weights should MV corporation use in its WACC

2. Book co. has 1.5 million shares of common stock equity with a par (book) value of $1.40, retained earnings of $28.1 million, and its shares have a market value of $51.74 per share. it also has debt with a par value of $19.1 million that is trading at 104% of par.

a. What is the market value of its equity?

b. What is the market value of its debt?

c. What weights should it use in computing its WACC?

3. Avicorp has a $10 million debt issue outstanding, with a 6% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 95% of par value.

(a) What is Avicorp’s pretax cost of debt?

(b) If Avicor faces a 40% tax rate, what is its after-tax cost of debt? The after-tax cost of debt for Avicor is:

4. Dewyco has preferred stock trading at $50 per share. The next preferred dividend of $4 is due in one year. What is Dewyco’s cost of capital for preferred stock?

5. Steady Company's stock has a beta of 0.24. If the risk-free rate is 5.8% and the market risk premium is 7.1%, what is an estimate of Steady Company's cost of equity?

(round to one decimal place)

6. HighGrowth Company has a stock price of $20. The firm will pay a dividend of $1 next year, and its divident is expected to grow at a rate of 4% per year thereafter. What is your estimate of HighGrowth's cost of equity capital?

7. CoffeeCarts has a cost of equity of 15%, an effective cost of debt of 4%, and it's financed 70% with equity and 30% with debt. What is this firm's WACC?

8. AllCity Inc is financed 40% with debt, 10% with preferred stock, and 50% with common stock. Its pretax cost of debt is 6%. Its preferred stock pays an annual dividend of $2.50 and is priced at $30. It has an equity beta of 1.1. Assume the risk-free rate is 2%, the market risk premium is 7% and AllCity's tax rate is 35%. What is its after-tax WACC?

9. Growth company's current share price is $20 and is expected to pay a $1 dicidend per share next year. After that, the firm's dividends are expected to grow at a rate of 4% per year.

Growth company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at a par with a coupon rate of 6.5%.

a. What is Growth Company's pre-tax cost of debt?

b. Growth Company also has preferred stock outstanding that pays $2 per share fixed dividend. If the stock is currently price at $28, what is Growth Company's cost of preffered stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at par with a coupon rate of 6.5%. What is Growth Company's pretax cost of debt?

d. Growth Company has 5 million common shares outstanding and 1 million preferred shares outstanding, at its total book value is $50 million. Its liabilitities have a market value of $20 million. If Growth Company's common and preferred shares priced as in parts a and b, what is the market value of Growth Company's assets?

e. Growth Company faces a 35% tax rate. Given the information in parts a through d, and your answers to those problems, what is Growth Company's WACC?

10. A retail coffee company is planning to open 100 new coffee outlets that are expected to generate, in total, $15 million in free cash flows per year, with a growth rate of 3% in perpetuity. If the coffee company’s WACC is 10%, what is the NPV of this expansion?

Question 13 Your firm has bonds outstanding with 18 years remaining until maturity. The bonds are trading for $1127 and pay a 8.5% coupon rate. Your firm faces a 32% tax rate. Based on this, the after-tax cost of debt financing is

None of the other answers are correct
7.23%
8.50%
4.92%
5.78%

Question 14 You have estimated the following values for dividends over the next four years.

D1 = $1.50

D2 = $2.50

D3 = $3.50

D4 = $4.50

In addition, you anticipate that you can sell the stock four years from today (immediately after you receive the year four dividend) for $50. Assuming a 9% required return, the value of the stock today is

$44.79
$45.64
$41.87
$49.49

Question 15 Developed equity markets have seen higher returns than emerging equity markets over the the Nov. 2004 to June 2012 time frame.

True
False

Question 16 You are evaluating a capital budgeting project that will cost $25,000

Year 1 ==> $12,000

Year 2 ==> $20,000

Year 3 ==> $9,000

The required return is 13% and the critical acceptance level is 1.9 years. Calculate the Internal Rate of Return and determine whether or not the project should be accepted based solely on the Internal Rate of Return.

The IRR is 21.33% and we should reject the project
The IRR is 17.27% and we should accept the project
The IRR is 17.27% and we should reject the project
The IRR is 21.33% and we should accept the project
None of the other answers is correct

Question 17 Linda is saving for retirement and would like to accumulate $800,000 at her retirement. She currently has $30,000 saved and would like to work for another 25 years. She plans to save $3500 at the end of each year over the next 25 years. What rate of return must she earn on her investments over the next 25 years?

10.95%
12.45%
8.76%
7.23%
9.42%

Question 18 Consider two projects:

Project A Project B

PP 2.8 years 3.0 years

IRR 12.5% 13.3%

NPV -$15,500 -$16,900

Assume that the projects both have a required return of 15% and a critical acceptance level (T) of 3.25 years. If these are independent projects we should

Take both projects A and B
Take project B and reject project A
Take neither project
Take project A and reject project B

Question 20 Your firm wants to raise $4924796 by issuing preferred stock. The stock has a par value of $50 and pays a 6% dividend, how many shares must be issued if the required return is 10% (ignore costs associated with issuing the shares known as floatation costs -- round to the nearest share)?

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