1.

WACC:
Cost of Preferred:
Share price = 1.50/0.12 = $12.50
rp =

1.50
= 12.5%
12.50 0.50

Total market value = (500000)(12.50) = $6,250,000

Cost of Debt:
6000000 500000 =

10000000
(1 + rD )10

rD = 6.16%

After tax cost of debt = 6.16%(1-0.4) = 3.7%

Total market Value = $6,000,000
Cost of Common:
Total market Value = $15 x 1000000 = $15,000,000
Total Value of Firm = 6250000 + 6000000 + 15000000 = $27,250,000
Weights on financing sources:
Common equity = 15000000/27250000 = 55%
Debt = 6000000/27250000 = 22%
Preferred = 6250000/27250000 = 23%
Therefore, 55% of financing is to come from common equity.
Total investment needed = cost + delivery + net working capital
= 1000000 + 50000 + 60000 = $1,110,000
Therefore, firm needs (0.55)1110000 = $610,500 in common equity financing
$200,000 of this can come from cash on hand, but the rest ($410,500) must come from
new issue of stock.
Cost of common without flotation costs =

$1(1.09)
+ 0.09 = 16.3%
15

Cost of common with flotation costs =

$1(1.09)
+ 0.09 = 16.6%
15 0.05(15)

200000
410500
16.3% +
16.6% = 16.5%
610500
610500

Overall cost of common equity =

WACC = (0.55)16.5% + (0.22)3.7% + (0.23)(12.5%) = 12.76%

NPV:
(i) Total investment = $1,110,000
(ii) Net cost savings = $90,000 per year
1

1
PV = 90000(1 0.4)

= $353,339.34
15
0.1276 0.1276(1.1276)

(iii) Depreciation tax shield = $60,000(0.4) = $24,000 per year

1

1
PV = 24000

= $157,039.71
15
0.1276 0.1276(1.1276)

(iii) cashflows at termination = salvage + net working capital recovery = 150000 + 60000
= 210000
Therefore:
NPV = -1110000 + 353339.34 + 157039.71 + 210000/(1.1276)10 = -$536,428
NPV < 0, therefore do not invest.
2.
The NPV would be lower because a higher discount rate should be used to reflect the
higher risk.
3.
Cost of Common:

rS = E[ R ] = R f + E[ R M R f ]
= 6% +1.3(13% 6%)
= 15.1%

Cost of Debt:
Bonds priced at par, therefore yield equals coupon rate. Therefore rD = 8%.
Cost of preferred:
rp =

2
= 11.11%
18

Market value of common = $65,000,000

Market Value of Debt = $50,000,000
Market value of preferred = $18 x 400000 = $7,200,000

Total value of firm = $122,200,000

65
50
7.2
WACC =
15.1% +
8%(1 0.4) +
11.11% = 10.65%
122.2
122.2
122.2

4.
Cost of Common:
Firm will have more than enough cash on hand, so no flotation costs.
2.50(1.1)
rS =
+ 0.1 = 17.86%
35
Cost of Debt:
Net price after flotation costs = 1070 70 = 1000 = par
Therefore, yield equals coupon = 8%
WACC = (0.45)8%(1-0.35) + (0.55)17.86% = 12.163%
5.
(a)
If no cash then will pay flotation costs for new equity.
rS =

2.50(1.1)
+ 0.1 = 18.05%
35(0.98) 0.15

WACC = (0.45)8%(1-0.35) + (0.55)18.05% = 12.268%

(b)
Investment requires $5,000,000(0.55) = $2,750,000 in common equity financing.
1500000
1250000
rs =
17.86% +
18.05% = 17.95%
2750000

2750000

WACC = (0.45)8%(1-0.35) + (0.55)17.95% = 12.213%

6.
(a)
After tax cost of debt = 8%(1-0.3) = 5.6%
1

1
PVtax shield = 20000(0.3)

= 45009.61
10
0.056 0.056(1.056)
1

1
PVlease payments = 30000(1 0.3) + 30000(1 0.3)

= 166355.52
9
0.056 0.056(1.056)
NAL = 250000

50000
45009.61 166355.52 = $9639.36
(1.056)10

NAL > 0 , therefore it is best to lease.

(b) NPV including leasing = $1,009,639.36
7.
(a) do not exercise option, option expires
Profit = -$2 (loss)
Return = -100%
(b) exercise option
Profit = (25-20)-2.50 = $2.50
Return = 2.50/2.50 = 100%
(c) exercise option
Profit = (30-25)-2 = $3
Return = 3/2 = 150%
(d) do not exercise option, option expires
Profit = -$2.50 (loss)
Return = -100%
(e) exercise option
Profit = (26-25)-2 = -$1 (loss)
Return = -1/2 = -50%
(f) exercise option
Profit = (25-24)-2.50 = -$1.50 (loss)
Return = -1.50/2.50 = -60%