Question

1. ABI Construction has a face debt value of $25 Million USDs trading at 93% with a pre-tax weighted cost of 8%. ABI common equity for the year was valued at $59 Million of USDs and preferred equity for $2 Million of USDs. The Preferred equity rate was calculated to be 20%. However, the common equity was to be calculated using CAPM approach, with a 3.5% risk free rate and a 8.5% market risk premium rate, assuming a 1 Beta. If the tax rate is 35%, What is this firm s WACC? Express your answers in strictly numerical terms. For example, if the answer is 5%, write 0.05"

2. Suppose ABI Construction is considering investing in a new project of urban development. The cost of the project is $12 Millions of USD. ABI expects that the non-incremental yearly cash flows from the project are $4 Million of USD for the next five years; e.g. that is $4 Million of USD each year. Using the calculated WACC in the previous question, what is the Net Present Value (NPV) of the project? Note: Express your answers in strictly numerical terms. For example, if the answer is five million dollars, write 5000000 as an answer."

Answer 1

WACC = Weight of common equity * cost of common equtiy + Weight of preferred equity * cost of preferred Equity + weight of debt * cost of debt

= (59/86) * .12 + (2/86)*0.20 + (25/86)* 0.052

= 0.0823 + 0.0046 + 0.0151

=0.102

or 10.20 %

Cost of Common equity (CAPM)= Risk free return + Beta ( Market risk premium)

= 3.5 + 1*8.5

= 12 %

Cost of debt = 8% * (1 - 0.35 ) = 5.2 %

Cost of preferred equity = 20%

2.) NPV = Present value of cash inflow - present value of cash outflow

=Cash flow* PVF - Cash outflow

= $4000000 * (10.20%, 5 years) - $12000000

= $4000000 * 3.7715 - 1200000

= 1508599.05 - 1200000

= 308,599