Please help me with all problems. Thanks! Neville Industries has a target capita
ID: 2669860 • Letter: P
Question
Please help me with all problems. Thanks!
Neville Industries has a target capital structure consisting of 40% debt, 10% preferred stock, and 50% common equity. The before - tax YTM on Neville's long - term bonds is 9.5%, its cost of preferred stock is 8%, and its cost of retained earnings is 12.5%. If the firm's tax rate is 40%, what is Neville's WACC if it doesn't have to issue new common stock? 9.90% 9.67% 8.99% 10.01% 9.33% Neville Industries undertakes a variety of projects with different levels of risk. Neville adds 2 percentage points to its WACC for high - risk projects and subtracts 2 percentage points from its WACC tor low - risk projects. In other words, the cost of capital for a high - risk project equals WACC + 2%, write a low - risk project uses a cost of capital equal to WACC - 2%. WACC remains the same for average - risk projects. Neville's management is considering the following list of projects, and each project's risk is indicated in the table below. Indicate which projects Neville Industries should accept. Check all projects that should be accepted.Explanation / Answer
We know WACC = Kd*(1-T)*Wd + Ks*Ws +Wp*Kp where Wp, Ws&Wd are weights of Pref stock, Equity & Debt, Kp, Kd & Ks are cost of Pref stock, Debt & Cost of equity. So we have Wd = 40%, Wp=10% & Ws=50%. Aso we have Kd = 9.5%, Ks = 12.5% & Kp = 8% and T=40% SO WACC = 9.5%*(1-40%)*40% + 12.5%*50% + 10%*8% = 9.33% ......Ans (1) Part 2: SO High risk project is acceptable if Exp Rate of return > WACC+2% or 11.33% & LOw risk project is acceptable if Exp Rate of return > WACC-2% or 7.33% For Avge projcts, Acceptance if Exp Rate of Return = WACC = 9.33% High Risk catergory : Proj C is acceptable Low Risk catrgory : Proj D&G are acceptable Avge Risk : Proj B&H are acceptable