Question

A company uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 12% as long as it finances at its target capital structure, which calls for 60% debt and 40% common equity. Its last dividend was $1.00 and expected dividend for the coming year is $1.06. Earnings and dividend is expected to grow at a constant growth rate for the foreseeable future. Its stock sells for $7.80; and issuance of new stock will cost the company $0.90 per share. Expected net income for the coming year is $612,000. The tax rate is 40% and there are 200,000 shares issued and outstanding. Investment opportunities available are the following: Project Investment ($) Returns (%) A 300,000 13.00 B 250,000 12.50 C 350,000 13.50 D 200,000 14.00 E 400,000 12.00 Which project/s, if any, should Wey Hu Sye Company select and what is the total investment for the coming year? [Explain your answer based on the Weighted Marginal Cost of Capital and Investment Opportunity Schedules].

Answer 1

cost of equity	(expected dividend/net proceeds after flotation cost)+growth rate	(1.06/6.9)+.06	21.36%
after tax cost of debt = interest rate*(1-tax rate)	12*(1-.4)		7.2
WACC
source	weight	cost	weight*cost
debt	0.6	7.2	4.32
equity	0.4	21.36	8.544
WACC = sum of weight *cost			12.864
Investment	Investment value	Return in %	WACC	Selected/ not selected		Investable amount
A	300000	13	12.864	Selected	13>12.86	300000
B	250000	12.5	12.864	Not selected	12.5 <12.86	0
C	300000	13.5	12.864	Selected	13.5>12.86	300000
D	200000	14	12.864	Selected	14>12.86	200000
F	400000	12	12.864	Not selected	12<12.86	0
total investable amount						800000