Exercise 1

Goku is considering a new project. The project will require $600,000 for new fixed assets,
$240,000 for additional inventory. The project has a 5-year life. The fixed assets will be
depreciated straight-line to a zero book value over the life of the project. At the end of the
project, the fixed assets can be sold for 20 percent of their original cost. The net working capital
returns to its original level at the end of the project. The project is expected to generate annual
sales of $980,000 with costs of $600,000. The tax rate is 25 percent and the required rate of
return is 10 percent. Calculate NPV, IRR and Payback period for the project. Based on NPV
criteria, should the firm accept the project, and why?

Exercise 2
Consider the following information about the portfolio which contains two stocks:
Return if State occurs
State of Economy Probability
Stock A Stock B
Boom 0.2 20% 15%
Normal 0.6 12% 7%
Recession 0.2 -8% -4%

a) What is the standard deviation of the returns and expected return of each stock?

b) What is the standard deviation of the returns and expected return on a $40,000 portfolio which
consists of stocks A and B? Stock B is valued at $15,000. If the expected T-bill rate is 3.70
percent, what is the expected risk premium on the portfolio?

Exercise 3

Metallica Ltd. has 8 million ordinary shares outstanding; 300,000, $100 par value, 6 percent
preferred shares; and $1,600,000 bank loan with interest rate of 9 percent.
Metallica’s ordinary shares currently sell for $5 each and have a beta (β) of 1.3.
The preferred shares have a current market value of $80 per share.
The risk-free rate of interest is 7 percent; the market risk premium is 8 percent and Metallica’s
income tax rate is 30 percent.

Required
Find Metallica’s weighted average cost of capital (WACC)