Question 1 Start with the partial model in the attached. The stock of Matrix Computing sells for $65, and last year’s dividend was $2.53. Security analysts are projecting that the common dividend will grow at a rate of 9% a year. A flotation cost of 12%
Question 1Start with the partial model in the attached.The stock of Matrix Computing sells for $65, and last year’s dividend was $2.53. Security analysts are projecting that the common dividend will grow at a rate of 9% a year. A flotation cost of 12% would be required to issue new common stock. Matrix’s preferred stock sells for $42.00, pays a dividend of $3.32 per share, and new preferred stock could be sold with a flotation cost of 10%. The firm has outstanding bonds with 25 years to maturity, a 15% annual coupon rate, semiannual payments, $1,000 par value. The bonds are trading at $1,271.59. The tax rate is 20%. The market risk premium is 5.5%, the risk-free rate is 7.0%, and Matrix’s beta is 1.2. In its cost-of-capital calculations, Matrix uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity.a. Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity.b. Calculate the cost of new stock using the dividend growth approach.c. Assuming that Matrix will not issue new equity and will continue to use the same tar-get capital structure, what is the company’s WACCQuestion 2Start with the partial model in the attached.Pinto.com has developed a powerful new server that would be used for corporations’ Internet activities. It would cost $25 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 12% of the year’s projected sales; for example, NWC0 = 12%(Sales1 ). The servers would sell for $21,000 per unit, and Pinto believes that variable costs would amount to $15,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2.5%. The company’s nonvariable costs would be $1.5 million at Year 1 and would increase with inflation. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project’s returns are expected to be highly correlated with returns on the firm’s other assets. The firm believes it could sell 2,000 units per year. The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment at the end of the project’s 4-year life is $1 million. Pinto.com’s federal-plus-state tax rate is 20%. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with an 8% project cost of capital and high-risk projects at 13%.Question 3You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Each project has a cost of $50,000, and the cost of capital for each is 10%.The projects’ expected net cash flows are as follows:Question 4Marvin Industries must choose between an electric-powered and a coal-powered forklift machine for its factory. Because both machines perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered machine will cost more, but it will be less expensive to operate; it will cost $102,000, whereas the coal-powered machine will cost $69,500. The cost of capital that applies to both investments is 10%. The life for both types of machines is estimated to be 6 years, during which time the net cash flows for the electric-powered machine will be $26,150 per year, and those for the coal-powered machine will be $20,000 per year. Annual net cash flows include depreciation expenses.Submit your answers in a Word document.
|INPUTS USED IN THE MODEL|
|Flotation cost for common||12%|
|Flotation cost for preferred||10%|
|Payments per year||2|
|Annual coupon rate||15%|
|Market risk premium, RPM||5.5%|
|Risk free rate, rRF||7.0%|
|Target capital structure from debt||40%|
|Target capital structure from preferred stock||10%|
|Target capital structure from common stock||50%|
|a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the the CAPM method and the dividend growth approach to find the cost of equity.|
|Cost of debt:|
|Semiannual yield = RATE =|
|Annual B-T rd =|
|B-T rd ×||(1 – T)||=||A-T rd|
|Cost of preferred stock (including flotation costs):|
|Dpf /||Net Ppf||=||rpf|
|Cost of common equity, dividend growth approach (ignoring flotation costs):|
|D1 /||P0 +||g =||rs|
|Cost of common equity, CAPM:|
|rRF +||b × RPM||=||rs|
|b. Calculate the cost of new stock using the dividend growth approach (include flotation costs).|
|D0 × (1 + g) /||P0 × (1 – F) +||g =||re|
|c. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the company’s WACC?|
|wd × A-T rd +||wpf × rpf +||ws × rs||=||WACC|
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