Firm XYZ has 2.5 million outstanding stocks, each selling for
$14 per share. The firm’s debt...
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Firm XYZ has 2.5 million outstanding stocks, each selling for$14 per share. The firm’s debt is publicly trading at 85 percent ofits $7.5 million face value. The firm pays a 4.7% rate of intereston its new debt and has a beta of 1.8. The corporate tax rate is40%. Assume that the risk premium on the market is 5% and that thecurrent Treasury bill rate is 2%.
a) Compute WACC
b) Consider project A: the project costs 4 million and willgenerate after?tax (year?end) cash flows of $0.80 million for 4years. The project has the same risk as the overall firm. Shouldthe project be accepted?
c) Consider now project B: the project costs 1 million and willgenerate after?tax (year?end) cash flows of $0.20 million for 8years. Note that this project presents no risks. Should the projectbe accepted?
d) Consider finally project C: the project costs 12.5 millionand will generate after?tax (year?end) cash flows of $1.5 millionfor 8 years. The project is less risky than the overall firm, andhence has a beta of 0.7. Should the project be accepted?
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3.9 Ratings (556 Votes)
market value of equity 250000014 35000000 market value of bond 750000085 6375000 cost of debt interest paymentcurrent market price 7500000476375000 553 after tax cost of debt 55314 332 cost of common stock risk free ratemarket risk premiumbeta 2518 11 WACC source market value weight component cost weightcomponent cost debt 6375000 015407855 332 05115408 common stock 35000000 084592145 11 9305136 total market value 41375000 WACC sum of weightcomponent cost 982 Project A Year cash flow present value factor 11rn r 992
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