COST OF CAPITAL

1. Assuming that the financial company can sell new common stock at $ 75 per
share. Find the company’s costs of internal and external equity for the following
situations:
a) Stockholders expect that the next dividend will be $ 9 and that dividends
will grow at 10% per year. Flotation costs are 6% of sale price.
2. X service has obtained the following information about the cost of new long term
financing:

Source Net precedes to firm

Bonds, $ 1000 par (7%) $ 980 per bond

Common stock, $20 par $ 20 per share

The firm expects earnings to be $ 3 per share for the foreseeable future and all
earnings are paid out as dividends. The firm’s tax rate is 40%.the firm’s most recent
balance sheet (in million of dollars) is:

Assets Claims
Current Assets $ 200 Current liabilities $ 100
Net fixed assets 400 Long term debt 300
Common equity 200
Total assets $ 600 Total claims $ 600
Assuming that X service will finance its future long term investments in about the same
capital proportions as it has in the past. Calculate the firm’s cost of capital using book
weights

3. Calculate the cost of debt for each of following situations where the company
issues $ 1000 face value bonds with maturity of 30 years. The bond is sold for
$1000 each.
a) The bonds pay 9% interest annually, flotation costs are 2% and tax rate is 40%.
b) The bonds pay 8% interest annually, flotation cost are 3% and tax rate is 40%
 c) The bonds pay $ 100 interest annually, flotation costs are 2% and tax rate is 40%

4. a) A firm’s after tax cost of capital of the specific sources is as follows:

Cost of debt 8%
Cost of preference share 14%
Cost of equity funds 17%
The following is the capital structure:
Source Amount
Debt $ 300000
Preference capital $ 200000
Equity capital $ 500000
Calculate the weighted average cost of capital using book value weights
b) The market values of different sources of funds are as follows:
Source Market value
Debt $ 270000
Preference capital $ 230000
Equity capital $ 750000
Calculate the weighted average cost of capital using market value weights.

5. You have following information:

Source Amount Market value
Debt $ 300000 $ 270000
Preference capital $ 200000 $ 230000
Equity capital $ 500000 $ 750000
The required rate of return cost of the different source of fund is given below:
Source Required rate of return Floating Tax
cost rate
Debt 10% 3% 40%
Preferred stock 12% 2% -
Common stock 13%(this is also the -
cost of capital)

Compute the WACC as per book value and market value weight.
6. The X shoe Company is preparing to issue some new 10 percent coupon, 20 year
bonds. Investors will pay $ 1000 pr bond when they are issued if the annual
 interest payments by the firm are $ 100 (a 10% coupon). The firm’s tax rate is
34% and floatation cost is 2%. What is the cost of debt?

CAPITAL BUDGETING
1. Ford Inc. is considering two mutually exclusive projects. Each requires an initial
investment of $100000. It has set a maximum payback period of 4 years. The after
tax cash inflows associated with each project are as follows:

Year Cash flows

Project A Project B
1 $ 10000 40000
2 20000 30000
3 30000 20000
4 40000 10000
5 20000 20000

i) Determine the payback period of each project.

ii) Because they are mutually exclusive, Ford must choose one. Which
should the company invest in?
iii) Explain why one of the projects is a better choice than the other.
2. Neil Corporation has three projects under consideration. The cash flows
for each project are shown in the following table. The firm has a 16% cost
of capital.

Project A Project B Project C

Initial investment $ 40000 $ 40000 $ 40000
Year Cash inflows
1 $ 13000 $ 7000 $ 19000
2 $ 13000 $ 10000 $ 16000
3 $ 13000 $ 13000 $ 13000
4 $ 13000 $ 16000 $ 10000
5 $ 13000 $ 19000 $ 70000
 a) Calculate each project’s payback period. Which project is preferred
according to this method?
b) Calculate each project’s NPV. Which project is preferred according to
this method?
c) Based on findings in a) & b), recommend the best project. Explain
your recommendation.

3. Calculate the IRR and NPV for Projects X and Y. Assume that k=10%
Project Year 0 Year 1 Year 2 Year 3
X -$ 80000 36000 36000 36000
Y - $ 160000 70000 70000 70000

4. Financial Analyst for the Kolbe Mining Company are considering the
following set of investment, which are not mutually exclusive. Each
project’s initial investment is $ 100,000.

Proposal PV of future CFAT ($)

1 $ 123000
2 139000
3 134000
4 264000
5 180000
6 418000
7 424000
8 170000
9 143000
10 74000

a) Which projects should the firm select if it has unlimited funds?

b) Which projects should the firm select if it must limit capital expenditures
this year to $ 500,000?
5. the expected cash flow of two projects are given below:
Year 0 Year 1 Year 2 Year 3 Year 4
Project
Tk. Tk. Tk. Tk. Tk.
Alpha (30000) 12500 10000 11500 9500
Gama (40000) 18500 13000 12500 11000
a) Compute each project’s payback period, net present value, and internal rate of
return if the cost of capital of the two projects is 12% and maximum payback
period is 3 years.
b) Which project(s) should be accepted if they are independent?
c) Which project(s) should be accepted if they are mutually exclusive?

6. Compute the Profitability index (PI) of the following project and whether the
project should be selected or not?

Year Discounted cash flow(discounted at 12%)

0 Tk.(47000)
1 23000
2 12700
3 7000
4 5500