Question

1. Use the following data to answer question Q14 - Q17

   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%, risk-free rate is 3%.

   Debt Benchmark:

   Par:100, Annual Coupon: 6%, 10-year to maturity, Selling at $88.43

   Q14. What is the before-tax cost of debt

   		7.7%
   		8.5%
   		6.3%
   		6.9%

10 points   

QUESTION 15

1. Q15. What is the cost of equity?

   		29%
   		35.69%
   		37.28%
   		28.14%

10 points   

QUESTION 16

1. Q16. What is the WACC?

   		33.14%
   		21.69%
   		26.37%
   		17.28%

10 points   

QUESTION 17

1. Q17. What is the NPV of the project?

   		1728.42
   		917.53
   		2231.98
   		860.42

Answer 1

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