Question

Giasgow company nas tne foiiowing Tinanciai data for project X (3-year project): Year Year 1 Year 2 Year 3 CF -10,000 5,000 4,000 4,000 The company's capital structure is distributed equally between debt, preferred stock and common stock. It has also the following information: 1- After tax cost of debt: 5.8%. Tax rate: 40% 2- Preferred stocks are selling at $65 per share and pay a dividend of $8 per share 3- Common stocks are selling at $40 per share, pay a year-end dividend of $2 per share and grow at a constant rate of 13%. The company is also considering another two projects "Y" & "Z" with the following information: Project Y 2.56 years $678.98 Project Z 3 years $282.24 Criterion Payback Period NPV IRR 15.19% 16% MIRR 14.48% 15%

Note: This problem is related to questions 1 to 9

1. The NPV for project X is: A. $500.18 B. -$500.18 C. $3,000 D. -$3,000 E. None of the above

2. The MIRR for project X is: * A. 12.38% B. 13.38% C. 31.38% D. 13.83% E. None of the above

3. The payback period for project X is: * A. 2.00 years B. 2.52 years C. 2.25 years

D. -2.25 years E. None of the above

4. The discounted payback period for project X is: A. 2.25 years B. 2.28 years C. 2.28 months D. 2.82 years E. None of the above

5. Assuming that the three projects X, Y & Z are independent, which project (s) should the company choose? * A. X, Y & Z B. X & Z C. Only X D. Only Y E. Reject all projects

6. Assuming that the three projects X, Y & Z are Mutual Exclusive, which project (s) should the company choose? * A. X, Y & Z B. X & Z C. Only X D. Only Y E. Reject all projects

7. Assuming that the three projects X, Y & Z are independent, then based on MIRR criteria which project (s) should the company choose? * A. X, Y & Z B. X & Y C. Only X D. Only Z E. Reject all projects

8. Assuming that the three projects X, Y & Z are Mutual Exclusive, then based on MIRR criteria which project (s) should the company choose? * A. X, Y & Z B. X & Y C. Only X D. Only Z E. Reject all projects

9. If IRR for "X" is 15.02%, and the three projects X, Y & Z are Independent, based on IRR criteria which project (s) should the company choose? * A. X, Y & Z B. X & Y C. Only X D. Only Y E. Reject all projects

Answer 1

1.Calculation of NPV of the project X

Weight of debt(Wd)=0.33

Weight of Preferred stock(Wp)=0.33

Weight of common stock(We)=0.33

Cost of preferred stock=Dividend/Share price=$8/$65

=12.31%

Cost of Common stock=(Next year dividend/Share price)+grwoth rate

=($2/40)+0.13

=0.18 or 18.0%

WACC=Cost of Common stock*We+Cost of preferred stock*Wp+After tax cost of debt*Wd

=18.0%*0.33+12.31%*0.33+5.8%*0.33

=6.341%+4.0623%+1.914%

=12.00%

NPV=Sum of Present value of all cash inflows-Initial cash outflows

Present value will be calculated using WACC as discounting rate

Present Value=Cash flows/(1+WACC)^no of year

NPV=[5,000/1+0.12)^1+4000/(1+.12)^2+4000/(1+.12)^3]-$10,000

=$10500.00-$10,000

=$500

Therefore correct answer is option A