CON589 Construction Finance

Assignment #3

1. Present value: What is the present value of:

a. $8,000 in 10 years at 6 percent?
b. $16,000 in 5 years at 12 percent?
c. $25,000 in 15 years at 8 percent?

Future value: If you invest $12,000 today, how much will you have:
a. In 6 years at 7 percent?
b. In 15 years at 12 percent?
c. In 25 years at 10 percent?

Time Value of Money: How much would you have to invest today to receive:
a. $12,000 in 6 years at 12 percent?
b. $15,000 in 15 years at 8 percent?
c. $5,000 each year for 10 years at 8 percent?
d. $40,000 each year for 40 years at 5 percent?
2.Assume a $40,000 investment and the following cash flows for two alternatives.

Year Investment X Investment Y

1 $ 6,000 $15,000

2 8,000 20,000

3 9,000 10,000

4 17,000 —
5 20,000 —

Which of the alternatives would you select under the payback method?
3 You are asked to evaluate the following two mutually exclusive projects for the Norton
Corporation. Using the net present value method combined with the profitability index approach,
which project would you select? Use a discount rate of 14 percent.

Project X ($20,000 Investment) Project Y ($40,000 investment)

Year Cash Flow Year Cash Flow

1......................... 1
$10,000 $20,000
..................................
2......................... 2
8,000 13,000
..................................
3......................... 3
9,000 14,000
..................................
4......................... 4
8,600 16,000
..................................

4 Using the same data as presented in #2, calculate the IRR of both projects. Would you
change the decision you arrived at in #2?
5 Brook’s Window Shields Inc. is trying to calculate its cost of capital for use in a capital
budgeting decision. Mr. Glass, the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost of capital.
The company currently has outstanding a bond with a 12.2 percent coupon rate and
another bond with a 9.5 percent coupon rate. The firm has been informed by its investment
banker that bonds of equal risk and credit rating are now selling to yield 13.4 percent.
The common stock has a price of $58 and an expected dividend (D1) of $5.30 per share.
The firm’s historical growth rate of earnings and dividends per share has been 9.5 percent,
but security analysts on Wall Street expect this growth to slow to 7 percent in future years.
The preferred stock is selling at $54 per share and carries a dividend of $6.75 per share.
The corporate tax rate is 35 percent. The flotation cost is 2.1 percent of the selling price for
preferred stock. The optimum capital structure is 40 percent debt, 25 percent preferred
stock, and 35 percent common equity in the form of retained earnings.
Compute the cost of capital for the individual components in the capital structure, and
then calculate the weighted average cost of capital.