Answer Q14
Given the following cash flows:
Year 
0 
1 
2 
3 
CF 
3,500 
600 
1,000 
Cash flow will grow at a constant rate g=6% 
We choose the following capital structure plan:
Debt 
Equity 

Plan 
30% 
70% 
Equity Benchmark:
The unlevered beta is 2, tax rate is 40%. Market Return is 16%, riskfree rate is 3%.
Debt Benchmark:
Par:100, Annual Coupon: 6%, 10year to maturity, Selling at $88.43
Q1) What is the beforetax cost of debt
a) 7.7% 

b)8.5% 

c)6.3% 

d)6.9% 
Q2) What is the cost of equity?
a)29% 

b)35.69% 

c)37.28% 

d)28.14% 
Q3) What is the WACC?
a)33.14% 

b)21.69% 

c)26.37% 

d)17.28% 
Q4) What is the NPV of the project?
a)1728.42 

b)917.53 

c)2231.98 

d)860.42 
1)
Coupon = 0.06 * 100 = 6
Before tax cost of debt = 7.7%
Keys to use in a financial calculator: FV 100, PMT 6, N 10, PV 88.43, CPT I/Y
2)
Levered beta = Unlevered beta [1 + D/E(1  tax)]
Levered beta = 2 [1 + 0.3/0.7(1  0.4)]
Levered beta = 2 * 1.25714
Levered beta = 2.5143
Cost of equity = Risk free rate + beta (market risk premium)
Cost of equity = 0.03 + 2.5143 (0.16  0.03)
Cost of equity = 0.03 + 0.32686
Cost of equity = 0.3569 or 35.69%
3)
WACC = 0.3*0.077*(1  0.4) + 0.7*0.3569
WACC = 0.01386 + 0.24983
WACC = 0.2637 or 26.37%
4)
Year 3 CF = 1000 * 1.06 = 1,060
Value at year 2 = CF3 / required rate  growth rate
Value at year 2 = 1060 / 0.2637  0.06
Value at year 2 = 5,203.73098
NPV = Present value of cash inflows  present value of cash outflows
NPV = 3500 + 600 / (1 + 0.2637)^{1} + 1000 / (1 + 0.2637)^{2} + 5,203.73098 / (1 + 0.2637)^{2}
NPV = $860.42
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