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FIN 6631 - Module 7

FIN 6631 - Module 7

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Published by Trang Doan
FIN6631 - Chapter 10
FIN6631 - Chapter 10

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FIN6631 TRANG DOAN MODULE 7

CHAPTER 9
9-2
LL’s after tax cost of debt = r
d
(1-T) = 0.08 x (1 – 0.35) = 0.052 = 5.2%
9-3
Component cost of preferred stock = r
ps
=

0.09 = 9%
9-5
Cost of common equity = r
s
=


+ g =

0.05 = 0.1333 = 13.33 %
9-6
Stock Beta = 0.8
Yield on a 3 month T-bill is 4%
Yield on a 10 year T-bond = 6% =>Risk-free Rate (R
f
) = 6%
Market Risk-premium (RP
M
) = 5.5%
Rate of Return on a Average Stock in the market last year was = 15%
Calculating Estimated Cost of Common Equity using CAPM:
According to CAPM:
r
E
= r
f
+ ß x (RP
M
)
r
E
= 6% + 0.8 x (5.5%)
r
E
= 0.06 + (0.8 x 0.055)
r
E
= 0.06 + 0.044
r
E
= 0.104 (or) 10.4%
Estimated Cost of Common Equity (r
E
) = 8.4%
9-7
WACC = w
d
r
d
(1-T) + w
ps
r
ps
+ w
s
r
s

FIN6631 TRANG DOAN MODULE 7

= 0.3 (0.06)(1-0.4) + 0.05 (0.058) + 0.65 (0.12)
= 0.0917 = 9.17%
9-8
WACC = = w
d
r
d
(1-T) + w
ps
r
ps
+ w
s
r
s

0.0996 = 0.09 (0.4)(1-0.4) + r
s
(0.6)
0.996 = 0.0216 + r
s
(0.6)
0.078 = r
s
(0.6)
r
s=
0.13

= 13%
Cost of Equity Capital = 13%
9-9
Using financial calculator:
N = 60
PMT = 30
PV = -515.16
FV = 1000
 I/Y = 6
 Semiannual payment = 12
After tax component cost of debt = r
d
(1-T) = 12 (1- 0.4) = 7.2%
9-11
a. Historical growth rate in earning:
P
5
= P
0
(1+g)
5

6.50 = 4.42(1+g)
5
(1+g)
5
= 6.50/4.42 = 1.471

FIN6631 TRANG DOAN MODULE 7

(1+g)
5
= 1.471
(1/5)
= 1.080

g = 8%
Using financial calculator, input N = 5; PV = -4.42; PMT = 0; FV = 6.50; => I/YR =
8.02% = 8%
b. The next expected dividend per share, D
1:

D
1
= D
0
(1+g) = 2.60(1.08) = 2.81
c. Cost of equity:
r
s
= D
1
/P
0
+ g = 2.81/36 + 8% = 15.81
9-15
a.
Required Investments = $30,000,000
Since the total market value of the firm is $60,000,000
Out of that, $30,000,000 is financed through equity, then the weight of equity =
$30,000,000 / $60,000,000 = 0.5
Common equity needed = Total Amount of Investment × Weight of Equity
= 0.5($30,000,000) = $15,000,000.
b.
Cost of Equity =
1
0
D
g
P
 =
$1.20
0.08
$30
 = 0.12 = 12%
After Tax Cost of Debt = Before Tax Cost of Debt × (1-Tax Rate) = 8 × (1-0.4) = 4.8%
WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × After Tax Cost of
Debt) = (0.5 × 12%) + (0.5 × 4.8%) = 8.4%
FIN6631 TRANG DOAN MODULE 7

c. If the capital structure is maintained ie Debt: Equity = 1:1 then WACC will remain the
same. Retained earning is also part of equity. Thus instead of retained earning as in the
previous case here the equity is being increased by the issue of new equity
CHAPTER 10
10-1
NPV = -52,125 +

= -52,125 + 59,611.65 = $7,486.65
10-2
Using Excel with IRR function, we can calculate IRR = 16%
10-3
Using financial calculator, N = 8, I = 12%, PV = 0, PMT = 12000
 FV = 147,596
Then we calculate MIRR
N = 8, PV = -52,125, FV = 147,596, PMT = 0 => MIRR = 13.89%
10-4
PI = PV of future cash flow/Initial cost = 59611.95 / 52125 = 1.143
10-5
0 1 2 3 4 5 6 7 8
-52125 12000 12000 12000 12000 12000 12000 12000 12000
-52125 -40125 -28125 -16125 -4125 7875 19875

Period payback = 4 +

= 4.343 years
FIN6631 TRANG DOAN MODULE 7

10-6
0 1 2 3 4 5 6 7 8
-
52125
12000 12000 12000 12000 12000 12000 12000 12000
10714.28 9566.32 8541.36 7626.21 6809.12 6079.57 8428.19
-
52125
-
41410.72
-
31844.4
-23303 -
15676.83
-
8867.71
-
2788.14
2640.05

Discounted payback period = 6 +

= 6.513 years
10-7
a. At 5%:
NPVA = -15000 +

= 16,108,952
NPVB = -15000 +

= 18,300,939
At 10%:
NPVA = 15000 +

= $12,836,213
NPVB = 15000 +

= $15,954,170
At 15%:
NPVA = 15000 +

= $10,059,587
NPVB = 15000 +

= $13,897,838
b. Using Excel to calculate IRR:
IRR
A
= 44%
FIN6631 TRANG DOAN MODULE 7

IRR
B
= 82%
10-8
Using excel to calculate:
IRR
T
= 15%
IRR
P
= 20%
NPV
T
= -17,100 +

+

= $408.71
NPV
P
= -22,430 +

+

= $3,318.10
Using financial calculator, for project Truck: N = 5; I = 14; PV =0; PMT = 5,100; we
have: FV = 33,711.53. Then we enter: N = 5; PV = -17,100; FV = 33,711.53; PMT =
0, we calculate: MIRR
T
= 14.53%
Do the same with project Pulley, N = 5; I = 14; PV = 0; PMT = 7,500 => FV =
49,575.78. Then we enter: N = 5; PV = -22,430; FV = 49,575.78; PMT = 0, we have
MIRR
P
= 17.19%
We accept both projects.
10-13
a. Construct NPV profiles for Projects A and B.
r NPVA NPVB
0% $890 $399
10 283 179
12 200 146
18.1 0 62
20 -49 41
24 -138 0
30 -238 -51
b.
IRR
A
= 18.1%; IRR
B
= 24.0%
FIN6631 TRANG DOAN MODULE 7

c. Project A has the higher NPV = $283.34
Project B has NPV = $178.60
For r = 17%:
Prject B NPV = $75.95
Project A NPV = $31.05
Project B would be selected.
d. MIRR for Project A when r = 10%:
PV costs = $300 + $387/(1.10)
1
+ $193/(1.10)
2
+ $100/(1.10)
3
+ $180/(1.10)
7
= $978.82
$987.82 = $2,459.60 (1 +MIRR)
7
MIRR
A
= 14.07%
MIRR
B
= 15.89%
At r = 17%:
MIRR
A
= 15.57%
MIRR
B
= 19.91%
e. The crossover rate, and its significance:
Year Project a
0 105
1 -521
2 -327
3 -234
4 466
5 466
6 716
7 -180
Cross over rate = 14.53%
Both projects are mutually exclusive but only the one with the cost of capital higher than
the crossover rate can be selected.
10-16
FIN6631 TRANG DOAN MODULE 7

Plane a:
Expected life = 5 years; cost = 100mil.; net cash flow = 30 mil; cost of capital = 12%
Plane b:
Expected life = 10 years; cost 132 mil.; net cash flow = 25 mil.; cost of capital = 12%
NPV = $9.26
Project a is better since it will increase the value of the company by $12.764 mil.
10-21

06)(1-0.0.09 (0.42 = 1.996 = 0.078 = rs (0.3 (0.0917 = 9.05 (0.12) = 0.0216 + rs (0.0996 = 0. Historical growth rate in earning: P5 = P0(1+g)5 6.13 = 13% Cost of Equity Capital = 13% 9-9 Using financial calculator: N = 60 PMT = 30 PV = -515.4) + 0.16 FV = 1000  I/Y = 6  Semiannual payment = 12 After tax component cost of debt = rd (1-T) = 12 (1.65 (0.4) + rs (0.4) = 7.50/4.50 = 4.058) + 0.2% 9-11 a.FIN6631 TRANG DOAN MODULE 7 = 0.6) rs= 0.42(1+g)5 (1+g)5 = 6.17% 9-8 WACC = = wdrd (1-T) + wpsrps + ws rs 0.4)(1-0.6) 0.6) 0.471 .

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