Lesson 7: Cost of Capital

Problem A
1 Net Proceeds 980.00

2 Cost of debt (before tax) 0.12

Tax Rate 0.70
Cost of debt (after tax) 0.09
3 121.33
990.00
Approximate cost of debt (before tax) 0.12
Tax Rate 0.70
Cost of debt (after tax) 0.09

Problem B
4 Cost of preferred stock 0.16

Problem C
5 Cost of preferred stock 0.11

Problem D
6 Cost of common stock equity 0.15

Problem E
7 Net Proceeds 52.00
8 Cost of retained earnings 0.12
9 Cost of new common stock 0.13

Problem F
10 Weighted Cost WACC
Debt 0.55 0.067 0.04
Preferred stock 0.10 0.092 0.01
Common stock 0.35 0.106 0.04
0.08
Lesson 8: Capital Budgeting
1.  Calculate each project's payback period. (15 pts)
Answer: Project M: 28,500 / 10,000 = 2.85 years
Project N: 2 + [(27,000 - 21,000) / 9,000] = 2.67 years

2.  Using payback period, which project should be accepted?  Why? (15 pts)
Answer: Project N should be accepted in using the payback period because it has a shorter payback

3.  Calculate the net present value (NPV) for each project. (15 pts)
Answer: Project M: 10,000 * PVIFA14%, 4 years - 28,500
= (10,000 * 2.914) - 28,500 = 640

Project N:
Year CFt PVIF (14%) PV = CFt * PVIF
1 11,000 0.877 9,647
2 10,000 0.769 7,690
3 9,000 0.675 6,075
4 8,000 0.592 4,736

PV (Cash inflows) 28,148

Initial investment 27,000
NPV 1,148

4.  Using NPV, are both projects acceptable?  Which project should be prioritized by Fitch? (20 pts)
Answer: Project N should be prioritiezed by Fitch because NPVN = 1,148 is greater than NPVM = 640

5.  Calculate the internal rate of return (IRR) of each project. (15 pts)
Answer: Project M: 0 = -28,500 + 10,000 (PVIFA)4,? 28,500 = 10,000 (PVIFA)4,?
Use PV of annuity table to search for the rate corresponding t
The rate is 15% which is the IRR.
Financial calculator is 15.1%

Project N: Search by trial and error. Try 16% to find DCF

11,000 (PVIF) .16,1 = 11,000 (.862) = 9482
+ 10,000 (PVIF) .16,2 = 10,000 (.743) = 7430
+ 9,000 (PVIF) .16,3 = 9,000 (.641) = 5769
+ 8,000 (PVIF) .16,4 = 8,000 (.552) = 4416
DCF = 27,097
NPV = 27,097 – 27,000
NPV =97
Therefore the IRR ≈ 16 %
Financial calculator is 16.2 %
6.  Using IRR, are both projects acceptable?  Which project should be prioritized by Fitch? (20 pts)
Answer: Fitch should prioritize Project N because IRRN = 16% is > IRRM = 15%
it has a shorter payback period.

by Fitch? (20 pts)

eater than NPVM = 640

500 = 10,000 (PVIFA)4,? (PVIFA)4,? = 2.850

the rate corresponding to 2.850 and 4 years.
by Fitch? (20 pts)