Question

Assume the firm’s debt−equity ratio is 200%. The project under consideration needs $600,000 initial cost. The firm can raise the fund by issuing common stock and debt. The cost of equity is 21%. The company can raise new debt at the cost of 9%. The flotation cost rate associated with equity is 9%, and the flotation cost rate associated with debt is 3%. This project will generate constant after-tax cash flows of $318,000 per year forever. Assume the tax rate is 40%. What is the net present value of the project if the flotation cost is considered?

Answer #1

Doubleday Brewery is considering a new project.
The company currently has a target debt–equity ratio of .40, but
the industry target debt–equity ratio is .25. The industry average
beta is 1.08. The market risk premium is 8 percent, and the
(systematic) risk-free rate is 2.4 percent.
Assume all companies in this industry can issue debt at the
risk-free rate. The corporate tax rate is 21 percent. The project
will be financed at Doubleday’s target debt–equity ratio. The
project requires an...

1. You are evaluating a 1-year project that is in line with the
firm’s existing business. Specifically, this new project requires
an investment of $1,200 in free cash flow today, but will generate
$1,600 one year from today. The project will be partially financed
with a 1-year maturity debt whose face value is $200 and interest
rate is 10%. Suppose that you estimated the cost of equity as 20%,
based on the firm’s stock data. However, you were not able...

[Q18-Q23] You are evaluating a 1-year project that is in line
with the firm’s existing business. Specifically, this new project
requires an investment of $1,200 in free cash flow today, but will
generate $1,600 one year from today. The project will be partially
financed with a 1-year maturity debt whose face value is $200 and
interest rate is 10%.
Suppose that you estimated the cost of equity as 20%, based on
the firm’s stock data. However, you were not able...

Suppose your company needs $24 million to build a new assembly
line. Your target debt?equity ratio is .60. The flotation cost for
new equity is 7 percent, but the flotation cost for debt is only 3
percent. Your boss has decided to fund the project by borrowing
money because the flotation costs are lower and the needed funds
are relatively small.
What do you think about the rationale behind borrowing the
entire amount?
What is your company’s weighted average flotation...

Southern Alliance Company needs to raise $25 million to start a
new project and will raise the money by selling new bonds. The
company will generate no internal equity for the foreseeable
future. The company has a target capital structure of 50 percent
common stock, 8 percent preferred stock, and 42 percent debt.
Flotation costs for issuing new common stock are 11 percent, for
new preferred stock, 6 percent, and for new debt, 6 percent. What
is the true initial...

Southern Alliance Company needs to raise $75 million to start a
new project and will raise the money by selling new bonds. The
company will generate no internal equity for the foreseeable
future. The company has a target capital structure of 70 percent
common stock, 5 percent preferred stock, and 25 percent debt.
Flotation costs for issuing new common stock are 7 percent, for new
preferred stock, 4 percent, and for new debt, 3 percent. What is
the true initial...

Dickson, Inc., has a debt-equity ratio of 2.2. The firm’s
weighted average cost of capital is 9 percent and its pretax cost
of debt is 6 percent. The tax rate is 21 percent.
a.
What is the company’s cost of equity capital? (Do not
round intermediate calculations and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)
b.
What is the company’s unlevered cost of equity capital?
(Do not round intermediate calculations and enter your...

A firm’s capital structure consists of 21% long-term debt. At
present, the company can raise debt by selling 17-year bonds with a
11.82% annual coupon interest rate. The firm is in a 32% income tax
bracket. Its bonds generally require an average discount of $40.92
per bond and flotation costs of $34.91 per bond when being sold.
Required: Calculate the firm’s current after-tax cost of long-term
debt.

Southern Alliance Company needs to raise $25 million to start a
new project and will raise the money by selling new bonds. The
company will generate no internal equity for the foreseeable
future. The company has a target capital structure of 55 percent
common stock, 9 percent preferred stock, and 36 percent debt.
Flotation costs for issuing new common stock are 14 percent, for
new preferred stock, 6 percent, and for new debt, 5 percent. What
is the true initial...

A firm has a debt to equity ratio of 2/3. Its cost of equity
is 15.2%, cost of debt is 4%, and tax rate is 35%. Assume that the
risk-free rate is 4%, and market risk premium is 8%.
Suppose the firm repurchases stock and finances the
repurchase with debt, causing its debt to equity ratio to change to
3/2:
What is the firm’s WACC before and after the change in
capital structure?
Compute the firm’s new equity beta and...

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