Question

Based upon the following facts calculate the Weighted Average
Cost of Capital (WACC) for **Student Success Corporation
(SSC)**:

**PART 1 – WACC**

- Tax rate = 40%
- Debt Financing: $10,000 Face Value 10-Year, 5% Coupon, Semiannual Non-Callable Bonds Selling for $11,040 New bonds will be privately placed with no flotation cost.
- Common Stock: Current Price $40; Current Dividend = $3.00 and Growth Rate = 5%.
- Common Stock: Beta = 1.1; Risk Free Rate 2.0%; Required Return of the Market 7%
- Capital structure: 40% Debt, 60% Common Equity

- What is the cost of debt?
- What is the cost of equity – use both CAPM and the Dividend Model?
- What is the WACC – for Equity you can use either answer above or an average?

**PART 2 – Capital Budget**

If **SSC** is deciding upon whether to approve a
capital project and the cash flows are as follows:

Year 0 (initial investment) $2,000

Year 1 Cash Flow $1,000

Year 2 Cash Flow $600

Year 3 Cash Flow $400

Year 4 Cash Flow $4,000

**Calculate:**

- Net Present Value (NPV) ____________________________
- Internal Rate of Return (IRR) ____________________________
- Payback Period ____________________________

Remember to use the WACC from above for the NPV and to compare to the IRR. Should this project be approved and why or why

Answer #1

PART 1

Cost of debt

Using financial calculator

Input: FV= 10000, N=10*2=20, PMT=5%*10000/2 = 250

PV=-11040

Solve for I/Y as 1.87

YTM = 1.87%*2= 3.7436%

After tax cost = 3.7436%*(1-40%) = 2.25%

Cost of equity: CAPM= Rf+Beta*(Rm-Rf)

= 2%+1.1*(7%-2%) = 7.5%

Dividend model = D1/Price+g

= 3*105%/40+ 5%

=12.875%

Average of two = 10.1875%

WACC = 40%*2.25%+60%*10.1875%= 7.01%

PART 2

NPV | $2,835.33 |

IRR | 45.31% |

Payback | 3 |

Since IRR is more than the cost of capital, the project is profitable.

Working

Year | Cash flow | Cumulative CF |

0 | -2000 | -2000 |

1 | 1000 | -1000 |

2 | 600 | -400 |

3 | 400 | 0 |

4 | 4000 | 4000 |

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