Part l A firm has the current liabilities and equity financing on its balance sh

Question

Part l A firm has the current liabilities and equity financing on its balance sheet. The firm has taxable income that puts it in a 35% federal tax bracket. and the state in which it operates levies a 4.7% income tax. Compute the firm's weighted average cost of capital. Interest/ROR Source Short-term loan Long-term loan Retained Eanings Common stock $ 4,000,000 $21,000,000 mings $35,000,000 7.0%. 45% 17.0 22.0% Proportion 0.04 0.21 0.35 0.40 $40,000,000 Part 2 The same firm is considering the following projects to improve its production process. If the firm has a capital budget of S1,250,000, which projects should be accepted by the rate of return criteria? What is the firm's opportunity cost of capital? Projeet First Cost Annual Benefit Life (years) $250.000 2 $300,000 3 S125,000 4 S 50,000 5 $375,000 6 $200,000 7 $500,000 $50,000 $70,000 $35,000 $12,500 $97,500 $32,000 $155,000 15 10 20 Part 3 From your estimates of the WACC in part I and the opportunity cost of capital in part 2, what do you estimate the firm's true MARR to be?

Explanation / Answer

Part 1 Calculation of Firm Weighted Average Cost of Capital Source Amount Interest / ROR Int. Amt Short Term Loan $4,000,000 7% $280,000 Long term Loan $21,000,000 4.50% $945,000 Retained Earnings $35,000,000 17% $5,950,000 Common Stock $40,000,000 22% $8,800,000 Total $100,000,000 $15,975,000 Weighted Avg Cost of capital = $15975000/$ 100000000 = 15.98% or 16% Part 2 Calculation of Opportunity Cost Of Capital Project First Cost Annual Benefit Life (years) Factor of IRR IRR Opportunity cost of Capital A B C A/B E E-16% 1 $250,000 $50,000 15 5.0000 18% 2% 2 $300,000 $70,000 10 4.2857 20% 4% 3 $125,000 $35,000 5 3.5714 12% -4% 4 $50,000 $12,500 10 4.0000 21% 5% 5 $375,000 $97,500 5 3.8462 9% -6% 6 $200,000 $32,000 20 6.2500 15% -1% 7 $500,000 $155,000 5 3.2258 15% -1% The factor of IRR is then located in the present value tables to see what rate of return it represents. Company should Accept the Project 1, 2 and 4 since their IRR is more than 16%. Part 3 MARR should be 16% OR MORE

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---