Question

Complete Problem 16 in Chapter 12 on Page 414 in the book (Organic Produce Corporation) and the supplement question below (based on your findings).

You must do all of your financial calculations in Excel and prepare a memo in Word. Your memo must addresses each the questions below:

Finding the WACC. Organic Produce Corporation has 6.3 million shares of common stock outstanding, 350,000 shares of 5.8 percent preferred stock outstanding, and 150,000 of 7.1 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $74 per share and has a beta of 1.09, the preferred stock currently sells for $107 per share, and the bonds have 20 years to maturity and sell for 109 percent of par. The market risk premium is 6.8 percent, T-bills are yielding 4.3 percent, and the firm’s tax rate is 34 percent.
a.	What is the firm’s market value capital structure?
b.	If the firm is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

Answer the 2 questions in Problem 16 (A and B)

Question 3 - In your own words explain how taking on more debt could reduce Organic Produce Corporation’s cost of capital, potentially leading to the optimal capital structure, but also leading to increased risk to the business.

Question 4 - In your own words explain what working capital management is and give an example of one way Organic Produce Corporation’s financial managers could improve the company’s working capital position.

Question 5 – Explain capital budgeting in your own words. Explain one capital budgeting method in detail and how Organic Produce Corporation’s weighted average cost of capital affects capital budgeting decisions.

You will be graded on correct financial analysis, proper use of technology, and business-like presentation.

Answer 1

As per policy, only one question is allowed to answer at a time, so answering Prob. 16 here:

Prob 16:
a : Firm's market value capital structure =
security quantity * market value of the security =
6.3m*74+0.35m*107+0.15m*1090=$667.15m
b: The firm should use the WACC to discount the projects' cash flows.
The WACC of the firm = We*Ce + Wp*Cp+Wd*Cd*(1-t)
Ce = Req return = rf + B * mp = 0.043+1.09*0.068=0.11712
The WACC of the firm = (466.2/667.15)*0.11712 + (37.45/667.15)*0.058
+(163.50/667.15)*0.071*(1-0.34) = 0.096583 or 9.66%