Question

Question 1 (Time Value of Money and WACC)

(a) You need to pay off a car loan within the next two years.
The payment will be $4,000 every

month. Today you have made a single deposit into a
return-guaranteed investment account

that will allow you to cope with all the monthly payments.
This account earns an effective

annual interest rate of 12.68250301%. The first payment will
be made in one month.

(i) Calculate the corresponding monthly rate for the
investment account.

(ii) “You need to have at least $96,000 at your account today
in order to make all the

payments on the car loan in the next two years.” True or
false? Briefly explain without

doing any time value of money related (i.e. PVA or FVA)
calculations.

(iii) What is the amount of the single deposit made
today?

(iv) If your mother is going to make the first year’s
repayments for you (as a birthday gift)

and thus you don’t need to withdraw the $4,000 every month
from the investment

account, how much more money will you have in your bank
account two years from

now?

(b) The Chief financial officer of Kurdishy Oil has given you
the assignment of estimating the

firm’s cost of capital. The present capital structure, which
is considered optimal, is as follows:

Market Value

Debt $40 million

Preferred stock 5 million

Common equity 55 million

The anticipated financing opportunities are:

1) Debt can be issued with a 15 percent before-tax cost.

2) Preferred stock will be $100 par, carry a dividend of 13
percent, and can be sold at $96

per share.

3) Common equity has a beta of 1.20, rM = 17% and rf =
12%.

Kurdishy’s tax rate is 40%.

(i) Calculate the after-tax cost of debt, cost of preferred
stock and cost of equity of Galaxy

Oil.

(ii) What is the cost of capital of Kurdishy Oil?

(iii) The CEO of Kurdishy asks you about the company’s capital
structure. She wants to

know why the company doesn't use more preferred stock
financing as it costs less than

debt. What would you tell the president? [Note: Confine your
answer to no more a

couple of lines.]

Answer #1

1.

monthly rate=(1+12.68250301%)^(1/12)-1=1.000%

annual rate with monthly compounding=12%

2.

False, one would need less than 12*4000*2=96000 as the interest
will be charged on declining balance

3.

=4000/1%*(1-1/1.01^24)

=84973.54903

4.

=4000/1%*(1.01^12-1)*1.01^12

=57163.84736

1.

After tax cost of debt=15%*(1-40%)=9.000%

2.

Cost of preferred stock=13%*100/96=13.542%

3.

Cost of equity=12%+1.20*(17%-12%)=18.000%

4.

Cost of capital=(40*9.000%+5*13.542%+55*18.000%)/(40+5+55)

=14.177%

5.

Preferred stock's dividends are not tax exempt and hence their
effective cost is higher than effective cost of debt

Question 1 (25 marks/ Time Value of Money and WACC
(a) You need to pay off a car loan within the next two years.
The payment will be $4,000 every month. Today you have made a
single deposit into a return-guaranteed investment account that
will allow you to cope with all the monthly payments. This account
earns an effective annual interest rate of 12.68250301%. The first
payment will be made in one month. (i) Calculate the corresponding
monthly rate for...

Question 1 (25 marks/ Time Value of Money and WACC)
(a) You need to pay off a car loan within the next two years.
The payment will be $4,000 every month. Today you have made a
single deposit into a return-guaranteed investment account that
will allow you to cope with all the monthly payments. This account
earns an effective annual interest rate of 12.68250301%. The first
payment will be made in one month.
(i) Calculate the corresponding monthly rate for...

(a) You need to pay off a car loan within the next two years.
The payment will be $4,000 every month. Today you have made a
single deposit into a return-guaranteed investment account that
will allow you to cope with all the monthly payments. This account
earns an effective annual interest rate of 12.68250301%. The first
payment will be made in one month.
(i) Calculate the corresponding monthly rate for the investment
account.
(ii) “You need to have at least...

The Chief financial officer of Kurdishy Oil has given you the
assignment of estimating the firm’s cost of capital. The present
capital structure, which is considered optimal, is as follows:
Market Value Debt $40 million Preferred stock 5 million Common
equity 55 million The anticipated financing opportunities are:
1) Debt can be issued with a 15 percent before-tax cost.
2) Preferred stock will be $100 par, carry a dividend of 13
percent, and can be sold at $96 per share....

You are saving for a down payment on a car. How much money do
you need to deposit into a savings account per month to have $8,000
in your account in two years? The interest rate on your account is
6%/year.

You are saving money to buy a Car.
You will need $20,000 as the price of the car today. If you can
make a down payment now of $8000 , and want to pay the rest by
installments,
how much each deposit per month should be if you want to pay
the rest of the amount in 24 months if the interest rate on the
deposit is 6% per year?
If you can deposit $664 per month how long will...

Cost of Capital (WACC):
1. Company XYZ’s financing plans for next year include the sale of
bonds with a 10% coupon rate. The company believes it can sell the
bonds at a price that will provide a yield to maturity (YTM) of
12%. If the company’s marginal tax rate is 35%, what’s the
company’s after-tax cost of debt capital?
2. Company ABC just financed with a 30-year bond issuing today.
The bond sold at $515.16 with semiannual coupon payments. The...

5. Solving for the WACC
The WACC is used as the discount rate to evaluate various
capital budgeting projects. However, it is important to realize
that the WACC is an appropriate discount rate only for a project of
average risk.
Analyze the cost of capital situations of the following company
cases, and answer the specific questions that finance professionals
need to address.
Consider the case of Turnbull Co.
Turnbull Co. has a target capital structure of 58% debt, 6%
preferred...

Based on the following set of information, do an EPS-EBIT
analysis. You need to consider the following financing options:
100% debt, 75% debt and 25% equity, 50% debt and 50% equity, 25%
debt and 75% equity, and 100% equity.
Amount of capital needed: $100 million
Estimated EBIT range
Low end: $30 million (recession scenario)
Midpoint: $40 million (normalcy scenario)
High end: $50 million (boom scenario)
•Interest rate: 4 percent
•Tax rate: 30 percent
•Stock price: $50
•Number of shares outstanding:...

The concept of after-tax Weighted Average Cost of Capital (WACC)
is a common issue when studying finance at all levels. The impact
of taxes, applicable to most forms of financing is a key component
of studies in the field of finance. The Assessment questions will
present the opportunity to assess and build upon your knowledge of
and ability to calculate the after-tax WACC and the cost of debt
and equity.
Read the fictional scenario and respond to the checklist
items...

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