Question

The capital structure of a company consists of debt and equity. The firm has 100,000 bonds outstanding that are selling at par value. The par value of each bond is $1,000. Bonds with similar characteristics are yielding a before-tax return of 8 percent. The company also has 10 million shares of common stock outstanding. The stock has a beta of 1.5 and sells for $30 a share. The return on U.S. Treasury bills is 4 percent and the market rate of return is 10 percent. The company’s tax rate is 25 percent. What is the firm’s weighted average cost of capital?

b)    The company is considering a five-year project that is expected to generate the following net (or total) after-tax cash flows.

                              ______________________________________________________

                Year                Total (or net) after-tax cash flow

                              ______________________________________________________

                              1                      $1,000,000
                              2                       3,000,000
                              3                      4,000,000
                              4                      6,000,000
                              5                      7,000,000

                              ______________________________________________________

The initial investment of the project is $12,000,000. The project has no net working capital requirement and no salvalge value. Assume that the project has the same risk as the firm overall. Find the net present value (NPV) of the project.

Answer 1