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22 Jun 2018

The adjusted present value method (APV), the flow to equity (FTE) method, and the weighted average cost of capital (WACC) method produce equivalent results, but each can have difficulties making computation impossible at times. Given this, which one of these is a correct statement? Use the FTE method when the level of debt is known over a project’s life. Use the WACC method when the level of debt is known over a project’s life. The APV method is the most commonly used method in actual practice. The WACC method is appropriate when the target debt-to-value ratio applies over a project’s life. The WACC method is preferred when evaluating a leveraged buyout.

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23 Jun 2018

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SHOW ALL WORK!!! Chapter 14 Mini Case: The Link Between Capital Structure and Capital Budgeting Review the mini case in Chapter 14 of your text. Complete all requirements of the case.??Fiera Corporation is evaluating a new project that costs $45,000. The project will be financed using 40% debt and 60% equity, thus maintaining the firm�s current debt-to-equity ratio. The firm�s stockholders have a required rate of return of 18.36%, and its bondholders expect a 10.68% rate of return. The project is expected to generate annual cash flows of $13,000 before taxes for the next two decades. Fiera Corporation is in the 36% tax bracket. Remember to show all your work.

1. Determine the firm’s weighted average cost of capital (WACC).

2. Calculate the traditional net present value (NPV) of the project using the WACC. Should the project be undertaken?

3. Using Modigliani and Miller’s Proposition II, determine the required return on unlevered equity.

4. Use the adjusted present value (APV) method to determine whether or not the project should be undertaken.

5. Use the flow-to-equity (FTE) method to calculate whether or not the project should be undertaken.

Which of the following risks cannot be diversified away?

A.

risk of a local natural disaster affecting company production

B.

risk created by world political happenings

C.

risk of losing a major contract

E.

risk of a failed marketing campaign

Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return?

A.

10.25%

B.

10.50%

D.

11.00%

E.

11.25%

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

A.

When held in isolation, Stock A has more risk than Stock B.

C.

Stock A would be a more desirable addition to a portfolio than Stock B.

D.

The required return on Stock A will be greater than that on Stock B.

E.

The required return on Stock B will be greater than that on Stock A.

Which of the following statements is CORRECT?

B.

Portfolio diversification reduces the variability of returns on an individual stock.

C.

The smaller standard deviation is, the less likely that actual returns will be closer to expected returns, the lower the investment risk.

D.

A stock with a beta of 1 is more risky than an average stock on the market.

E.

A well-diversified investor will require to earn higher return on stocks with higher beta.

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? (WACC is the weighted average cost of capital, the financing rate, or discount rate)

A.

The project’s IRR increases as the WACC declines.

B.

The project’s NPV increases as the WACC declines.

D.

The project’s IRR decreases as the WACC declines.

E.

none of the above is correct.

Burlees Inc.’s CFO has collected the following information to calculate its WACC:

• The company’s capital structure consists of 60% debt and 40% common stock.

The company has 20-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,200.

The company uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 3% and the market risk premium is 5%. The company’s common stock has a beta of 2.

The company’s tax rate is 40%.

What is the company’s cost of common equity?

A.

9.65%

B.

13.00%

D.

17.60%

E.

18.91%

Burlees Inc.’s CFO has collected the following information to calculate its WACC:

• The company’s capital structure consists of 60% debt and 40% common stock.

The company has 20-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,200.

The company uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 3% and the market risk premium is 5%. The company’s common stock has a beta of 2.

The company’s tax rate is 40%.

What is the company’s weighted average cost of capital (WACC)?

A.

8.69%

B.

9.21%

D.

11.04%

E.

12.51%

Which of the following statement is correct?

A.

Higher flotation costs tend to reduce the cost of equity capital.

C.

The component cost of preferred stock is expressed as rp(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of debt interest.

D.

A higher risk project’s WACC should be adjusted higher.

E.

Retained earnings bear no capital cost at all.

I need help proof reading my assignment please, thank you in advance.

Cost of Debt

The cost of debt is the effective rate that a company pays on its total debt.

As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing. This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.

1. Cost of debt (before tax) = Corporate Bond rate of company’s bond rating.

Pepsico 2.75% = 2.75%

Current cost of Debt as of February 17th 2014 = 2.75%

2. Current tax rate

In 2013 PepsiCo’s tax rate was = 23.66%

2013 PepsiCo averaged tax rate of 23.66%

3. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 – Tax Rate)

The effective rate that a company pays on its current debt after tax.

.0275 x (1 – .2366) = Cost of debt after tax

The cost of debt after tax for PepsiCo is 2.10%

Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return – Risk Free Rate)

The cost of equity is the return a firm theoretically pays to its equity investors to compensate for the risk they undertake by investing in their company.

Risk Free Rate = U.S. 10-year bond = 2.74%

Average Market Return 1950 – 2014 = 7%

Beta = PepsiCo’s Beta = 0.37

Risk Free Rate + Beta Equity (Average Market Return – Risk Free Rate)

2.74 + 0.37 (7- 2.74)

2.74 + 0.37 x 4.26

2.74 + 1.58 = 4.31%

Currently, PepsiCo’s has a Cost of Equity or R Equity of 4.31%, so investors should expect to get a return of 4.31% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.

Weighted Average Cost of Capital or WACC calculation

The WACC calculation is a calculation of a company’s cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.

As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk. By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances. For this calculation, you will need to know the following listed below:

Tax Rate = 23.66%

Cost of Debt (before tax) or R debt = 2.75%

Cost of Equity or R equity = 4.31%

Debt (Total Liabilities) for 2013 TTM or D = $53.069 billion

Stock Price = $78.09 (Feb. 17th, 2014)

Outstanding Shares = 1.55 billion

Equity = Stock price x Outstanding Shares or E = $121.04 billion

Debt + Equity or D+E = $174.109 billion

WACC = R = (1 – Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 – Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 – .2366) x .0275 x ($53.069 /$174.109) + .0431 ($121.04 /$174.109)

.7634x .0275 x .3048 + .0431 x .6972

.0064 + .03

= 3.64%

Based on the calculations above, we can conclude that PepsiCo pays 3.64% on every dollar that it finances, or 3.64% cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0673 plus the cost of the investment for the investment to be feasible for the company.

Understanding the WACC of a company is important because securities analysts employ WACC all the time when valuing and selecting investments. In discounted cash flow analysis, for instance, WACC is used as the discount rate applied to future cash flows for deriving a business’s net present value.

Investors use WACC as a tool to decide whether to invest. The WACC represents the minimum rate of return at which a company produces value for its investors. Let’s say a company produces a return of 20% and has a WACC of 11%. That means that for every dollar the company invests into capital, the company is creating nine cents of value. By contrast, if the company’s return is less than WACC, the company is shedding value, which indicates that investors should put their money elsewhere.

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