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Complete question:
WACC Estimation
On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $20 million in new projects. The firm's present market value capital structure, here below, is considered to be optimal. There is no short-term debt.
Debt $30,000,000
Common equity 30,000,000
Total capital $60,000,000
New bonds will have an 7% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 = 4%.) The marginal tax rate is 40%.
1. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Enter your answer in dollars. For example, $1.2 million should be entered as $1200000.
$
2. Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC? Round your answer to two decimal places.
%
3. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question.
I. rs will increase and the WACC will decrease due to the flotation costs of new equity.
II. rs will decrease and the WACC will increase due to the flotation costs of new equity.
III. rs and the WACC will not be affected by flotation costs of new equity.
IV. rs and the WACC will increase due to the flotation costs of new equity.
V. rs and the WACC will decrease due to the flotation costs of new equity.
-Select- one above IIIIIIIVV
Answer:
The answer is III.
rs and the WACC will increase due to the flotation costs of new equity.
Solution:
It is given that,
Equity is $30,000,000.
Debt is $30,000,000.
The amount of fund raised is $20,000,000.
The formula to calculate weight of equity is given below:
Substitute $30,000,000 for equity and $30,000,000 for debt in the formula,
= 50%
Since weight of equity is 50% and to maintain this capital structure, company should finance the 50% of funds
Amount financed by common equity = $20,000,000 * 50%
= $10,000,000
Solution :
Calculating the (NPV) Net Present value for the following matters to check the feasibility of the replacement of an 8 year old riveting machine with the new one :
Let
A = Year (n)
B = Initial outlay
C = Five-year MACRS depreciation percentage
D = Depreciation with MACRS Method (D)
E = Savings in earnings before depreciation
F = Taxable Income (earnings before depreciation - depreciation
G = Income taxes (Taxable Income *40%)
H = cash flow
I = PV of at the rate
=
/
A B C D E F G H I
0 82,500 -82,500 -82,500
1 20% 16500 27000 10500 4200 22800 20357.14
2 32% 26400 27000 600 240 26760 21332.91
3 19% 15675 27000 11325 4530 22470 15993.70
4 12% 9900 27000 17100 6840 20160 12812.04
5 11% 9075 27000 17925 7170 19830 11252.07
6 6% 4950 27000 22050 8820 18180 9210.55
7 0% 0 27000 27000 10800 16200 7328.06
8 0% 0 27000 27000 10800 16200 6542.91
NPV $22,329.39
As the NPV, the project is positive ($22,329.39) and so the company should replace the 8 year old riveting machine with the new one.