Answer:
1. The cost of equity can be derived from the share price, which is the present value of the expected dividend one year from now(using the present value of growing perpetuity) as shown below:
share price=D1/(r-g)
share price=$500
D1=expected dividend one year from now=$4
r=cost of equity=unknown
g=constant growth rate=9%
$500=$4/(r-9%)
$500*(r-9%)=$4
r-9%=$4/$500
r=($4/$500)+9%
r=9.8
the Cost of Equity for the project is 9.8%
2. Compute the relevant cost of debt for this project is 5.53%
Market Value= 1,150
Face Value= 1,000
Term= 5 years, 10 semi-annual periods
Coupon Rate= 9%, 4.5% semi-annual rate
Tax Rate= 30%
N=10(semiannual coupons in 5 years)
PMT=45(semiannual coupon=face value*coupon rate/2=$1000*9%/2=$45)
PV=-1150(current market price)
FV=1000(face value of the bond is $1,000)
CPT(press compute)
I/Y=2.762766%(semiannual yield)
annual yield=2.762766%*2
annual yield=5.53%
3. The weighted average cost of capital is the sum of equity and the after-tax cost of debt multiplied by their respective market value weights
WACC=(cost of equity*weight of equity)+(after-tax cost of debt*weight of debt)
cost of equity=9.80%
the market value of equity raised=shares issued*market price of the share
the market value of equity raised=80,000*$500
the market value of equity raised=$40 million
weight of equity=market value of equity/total amount raised
weight of equity=$40 million/$100 million
weight of equity=40.00%
weight of debt=1-weight of equity
weight of debt=1-40.00%
weight of debt=60.00%
after-tax cost of debt=bond yield*(1-tax rate)
the after-tax cost of debt=5.53%*(1-30% )
the after-tax cost of debt=3.87%
WACC=(9.80%*40.00%)+(3.87%*60.00%)
WACC= 6.2426% or 6.24%
Therefore the WACC is 6.2426% or 6.24% rounded off to 2decimal place
4. Determine the initial cash flow for the project =$100 million
The initial cash outlay is the sum of the plant and machinery and net working capital investment required to commence the project
Plant and machinery= $80 million
Networking capital = $20 million
Total Initial Cash Flow= $100 million
5. Determine the earnings before taxes for years 1 through 5
Year
1 2 3 4 5
Revenue
120,000,000 120,000,000 120,000,000 120,000,000 120,000,000
Expenses
(80,000,000) (80,000,000) (80,000,000) (80,000,000) (80,000,000)
Depreciation (20,000,000) (15,000,000) (11,250,000) (8,437,500) (6,328,125)
EBT
20,000,000 25,000,000 28,750,000 31,562,500 33,671,875
Step-by-step explanation:
5. Depreciation schedule:
Year 1 = 80 × 25% = 20
Year 2 = (80-20) × 25% = 15
Year 3 = (80-20-15) × 25% = 11.25
Year 4 = (80-20-15-11.25) × 25% = 8.4375
Year 5 = (80-20-15-11.25-8.4375) × 25% = 6.328125
EBT = revenue - Expenses - depreciation
Year 1 = 120 - 80 - 20 = 20 Million
Year 2 = 120-80- 15 = 25 Million
Year 3 = 120-80- 11.25 = 28.75 Million
Year 4 = 120-80- 8.4375 = 31.5625 Million
Year 5 = 120-80- 6.328125 = 33.671875Million
