Question

1. The Weighted Average Cost of Capital (WACC) estimates the cost associated with raising new or weighing the cost of existing capital for an organization. If a firm has determined that the cost of capital for their bonds is 7% with an equity weight of 15% while common stock has a 5% cost of capital and 85% equity weight, what is the firm’s WACC?

2.A firm’s accountant has generated the following income statement for an upcoming 3 year expansion project that requires a $60,000 investment. The firm’s financial consultant requires this statement in order to calculate the free cash flows. Assume a 34% tax rate and a straight-line depreciation generating $125,000 in annual revenue and $60,000 in annual fixed costs.

Annual Revenue $125,000

Annual Fixed Costs $60,000                    

Depreciation ?

Tax ?

Net Income ?

Annual Free Cash Flow ?

Calculate the respective amounts and you must show your work for each to receive full credit:

A. Depreciation =

B. Tax =

C. Net Income =

D. Annual Free Cash Flow =

Answer 1

Answer :1 Calculation of WACC

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt * Weight of Debt)

= ( 5% * 0.85) + (7% * 0.15)

= 4.25% + 1.05%

= 5.30%

Answer :2

Calculation of Amount of Depreciation

Given that depreciation is charged on Straight line Method

Depreciation to be charged each year = Cost of Asset / Useful Life

  = 60,000 / 3

= 20,000

Below is the Table showing Calculation of Annual Free cash Flow

	Workings	Amount
Annual Revenue	Given	125,000
Annual Fixed Cost	Given	60,000
Depreciation	Calculated Above	20,000
Earning Before Taxes	Annual Revenue- Annual Fixed Cost- Depreciation	45,000
Taxes	45000 * 34%	15,300
Net Income	Earning Before Taxes -Taxes	29,700
(+) Depreciation	Reason: Being Non cash item	20,000
Annual Free cash Flow	Net Income + Depreciation	49,700