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ADMS1500 Exam Review Why might you prefer holding shares to holding debt in a company? -Leverage company with a lot of debt is highly leveraged, which is good for the shareholders. It means that they have less risk, and higher participation. -Debt holders are entitled to a fixed amount of interest -It only works if the company is going to be successful. More debt= more interest, more risk. -You would prefer to hold shares if you would like a risk -Debt with low debt to equity ratio = holding debt is more secure What are the main differences between preferred shares and common shares? Are all preferred shares the same? -Common shares have the residual, preferred shareholders have some sort of preference (in voting, income) Weighted average cost of capital: - to debt and equity being combined together, Percentage figure ABC Company has \$10 million debt at 8% and \$20 million common share equity. Tax rate is 30%. Required rate of return of common shareholders is 20%. Calculate the weighted average cost of capital. Debt=8% Equity=20% Tax Rate on Debt=1-30% =70% Tax Rate on Equity=1 WACC IS ALWAYS A PERCENTAGE FIGURE Rate % Tax Adjustment Proportion Weighted AVG / total Assets Cost of Capital Debt 8 0.70 0.3 1.87 Equity 20 1 0.7 13.33 Total 15.20 Right Company has \$200 000 debt at 12% and \$100 000 common share equity. Tax rate is 30%. Required Rate of return of common shareholders is 18%. Calculate the weighted average cost of capital. Rate% Tax Adjustment Proportion WACC /total assets Debt 12 0.70 0.67 5.60 Equity 18 1 0.33 9.00 Total 11.60 ABC Company has \$10 million debt at 10% and \$10 million common share equity. Tax rate is 25%. Required rate of common shareholders is 20%. Calculate the WACC Rate% Tax Adjustment Proportion WACC /total assets Debt 10 0.75 0.50 3.75 Equity 20 1.00 0.50 10.00 Total 13.75 PAYBACK, PRESENT VALUE, ROI, ROIA PROBLEM#1: ABC Company has a 5 year investment opportunity with an upfront non-refundable cost of \$150 000. The risk adjusted cost of capital is 12%. Cash flows are \$40 00 per year. Using payback, net present value, and return on average investment would you recommend accepting the investment? Give details of your calculations. PAYBACK: (how soon it will be paid back) Investment of \$150 000 , Annual Cash flow = \$40 000 per year 150 000/40 000 = 3.8 .: It will be repaid in 3.8 years RETURN ON AVERAGE INVESTMENT: Average net income / investment 10 000 / 150 000 = 6.67% ^Double the figure to get return on average investment .: Return on average investment = 13.33% Year Cash Flow Amortization Net Income 1 40 000 30 000 10 000 2 “ ” “ ” “ ” 3 “ ” “ ” “ ” 4 “ ” “ ” “ ” 5 “ ” “ ” “ ” NET PRESENT VALUE: Amount is the same every year= use annuity table. Annuity Rate Years Table Value Amount Present Value 0.1200 5.0 3.6048 40 000 144 192 Subtract Present value from investment. 144 192-150 000= -6 000 .:Since there is a negative figure, it is not a viable option. PROBLEM#2: Triac Company has a 5 y
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