Corporate Finance Case Study - 1402 Words

Solution to Case 23 Evaluating Project Risk It’s Better to Be Safe Than Sorry! Questions: 1. What seems to be wrong with the way the NPV of each project has been calculated? Indicate without any calculations, how Pete and John should go about recalculating the projects’ NPVs. The NPV of each project has been calculated by discounting the cash flows at the 8% before-tax cost of debt. This is incorrect. Since the company has debt, preferred stock and common stock in its capital structure the weighted average cost of capital must be calculated and used to discount the projects’ cash flows. The weight of each component of the target capital structure (based on market values of outstanding securities)†¦show more content†¦Please explain. TABLE 6 Expected Growth Rate of Sales†¦ 25% Expected Growth Rate of Earnings and Dividends†¦ 12% Expected Return on the Market†¦.. 15% Treasury bill rate†¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦. 6% Expected retention rate†¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦.. 60% Firm’s Equity Beta†¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦.. 1.2 AFTER-TAX COST OF DEBT (Without flotation costs) Calculate the Yield to maturity on the firm’s outstanding 8%, 20-year bonds which are currently selling at $900. PMT = 80; FV = 1000; N=20; PV = -900; CPT I% = 9.10% After-tax cost of debt = YTM*(1-Tax rate) = 9.1*(1-.4) = 5.46% COST OF PREFERRED STOCK (without flotation costs) = Dividend/Price of Preferred Stock = $0.6/$12 = 5% COST OF EQUITY (without flotation costs) Based on CAPM = Risk-free rate + Beta (Expected Market Return – Risk-free rate) = 6% + 1.2 (15% - 6%) = 6 + 10.8% = 16.8% Based on Dividend Discount Model = [D0 (1+g)/P0] + g = .51(1.12) / $25 + .12 = 14.28% Average of two estimates = (16.8 + 14.8)/2 = 15.54% These costs can and most likely will change as the firm’s overall level of debt increases. These changes will be caused by increased issue costs and increased risk premiums. For example: Once the firm uses up all of its available retained earnings, its cost of equity willShow MoreRelatedCorporate Finance Case Study3492 Words   |  14 Pagesinterest of the Italian State to buy this stake before the group is put on the market so as to present a streamlined structure? 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In a few phrases, describe the situation of the Roberto and Chez Leon chainsRead MoreCase Study : Corporate Finance And Investment Planning Essay5132 Words   |  21 PagesAmity Business School Amity University Uttar Pradesh Noida, U.P. July, 2015 Declaration I, Harshit Goel, student of B.Tech ECE + MBA, Amity Business School, Amity University Uttar Pradesh, Noida, hereby declare that the project titled â€Å"Corporate Finance and Investment Planning† which is submitted by me and carried out at Micromax Informatics Ltd. 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