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Date |
INSTRUCTIONS: Please complete this examination and bring it to class on the due date indicated on the syllabus. Remember this shall be an individual effort, and you shall not give or receive assistance in the completion of this examination. Please show all work, and feel free to attach additional pages as necessary. Full credit will not be given for providing only an answer, even if the answer is correct.
1.
Compute the average cost of debt for a corporation whose long-term debt consists of the following:
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Bonds ($1,000 face value, semi-annual coupon payments) |
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Type |
Amount Outstanding |
Coupon Rate |
Prevailing Rate |
Year |
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Mortgage Bonds |
$170,000,000 |
6.00% |
5.00% |
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Debentures |
$ 50,000,000 |
9.25% |
10.00% |
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Subordinated Debentures |
$ 12,000,000 |
9.00% |
10.50% |
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Convertible Bonds |
$ 8,000,000 |
8.25% |
7.75% |
At a marginal tax rate of 40%, what would be the after-tax weighted average cost of its debt? (20 points possible)
2.
The long-term debt of Bayboro Industries, Inc. consists of bonds with an average cost of 7.5% and term loans. If the firm’s tax rate is 40%, and bonds comprise 74% of total long-term debt, what would be the average cost of the term loans if the weighted average after-tax cost of debt is 4.578%? (10 points possible)
3.
Consolidated Frooble, Inc. has an issue of cumulative preferred stock paying an 11.5% annual dividend. If the issue had a 7% flotation cost and a $100 par value, calculate its capital component cost. Why is the capital component cost of the preferred stock different from the annual dividend rate? HINT: An answer that merely states the flotation cost is the reason the cost of the preferred stock is different from the annual dividend rate is not a sufficiently detailed answer. (10 points possible)
4.
The Potable Ethanol Corporation uses the Capital Asset Pricing Model (CAPM) to compute its cost of existing common equity. If the firm computes its common equity cost at 21.30% using the CAPM and estimates the risk-free rate is 1.5%, what value does the firm use for returns in the stock market if the firm’s beta coefficient is 1.5? (15 points possible)
5.
A firm has a capital structure consisting of 60% long-term debt at an average cost of 9.8%, 5% preferred equity at a cost of 10.5% and 35% common equity having an average cost of 15.5%. If the firm’s marginal tax rate is 40%, what would be the firm’s weighted average cost of capital (WACC)? (10 points possible)
6.
Cockroach Bay Mining is contemplating investment in new technology for processing phosphate rock. The operations manager reports the cost to purchase and install the new machinery will be $75,500,225. He estimates the equipment will produce
$5,000,000
in annual savings over its 40 year life. Compute the payback period in years and the Net Present Value of this investment. (10 points possible)
7.
Evaluate the capital project below. Your firm has a hurdle rate of 15.75% for capital projects of this type. The initial outlay for the project is $65,500,000 and the project is expected to generate the following cash flows over its 15 year life:
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Cash Flow |
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$2,100,000 |
$4,600,000 |
$5,900,000 |
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$3,500,000 |
$4,350,000 |
$6,000,000 |
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$3,750,000 |
$6,300,000 |
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$4,250,000 |
$5,700,000 |
$6,250,000 |
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$4,500,000 |
$5,500,000 |
$6,500,000 |
For the project, compute the payback period in years, the Net Present Value (NPV) and the Internal Rate of Return (IRR). Prepare a succinct summary of your findings and recommendation. (25 points possible)
