Question

Please show your work on the next following questions. Do not use Excel, handwritten answers. Thank you

Roberto Inc. is a manufacturing company. The company has always followed their ideal capital structure which the management insists is 40% debt and 60% equity capital. The company can issue bonds for 9% coupon rate with 22 years to maturity. The interest is paid semi-annually. The bonds can be issued with a price of $835.42 today. Roberto's marginal tax rate is 40%. For cost of equity, the company uses the CAPM based on SML. The risk-free rate in the market is 8% and the market rate of return is 14%. The company has a beta of 1.1. Roberto is experiencing a highly abnormal growth rate of 30%. This growth rate is expected to continue for four years. After year four, the growth rate is expected to return to a normal 8% and remain constant afterwards for the foreseeable future. Roberto just paid a dividend of $1.15. Furthermore, Roberto is evaluating several projects to invest in. The top project that is being considered will cost $1,000,000 and promises to pay $500,000 in year one, $400,000 in year two, $300,000 in year three and $100,000 in year four. This project will cease to exist with no salvage value at end of year four. So, the cash flow would look like the following: CF (S in 000's) Year 0 -1,000 (Initial Outlay) 1 500 2 400 300 4 100 Based on the information provided above, answer the following questions:

Answer 1

3.
Cost of equity = rf +beta * (rm - rf)
= 0.08 + 1.1 * (0.14 -0.08)
= 0.08 + 0.066
= 0.1460 or 14.6%

Cost of equity= 14.6%

4.
Effective interest rate = (1+(r/n)^n) - 1
= (1+(0.09/2)^2) - 1
= 0.092025 or 9.2025%

Cost debt after tax = (Interest payment/Bond price)* (1-t)
= (92.025 / 835.42) * (1-0.40)
= 6.6%

WACC = (cost of debt after tax * weight of debt) + (Cost of equity * weight of equity)
= (6.6 * 0.40) + (14.6 * 0.60)
WACC= 11.40%

5.

Dividend at the end of year 4 = 1.15 * 1.30^4 = 3.2845
Dividend at the end of year 5 = 3.2845 * 1.08 = 3.5473
Price at the end of 4th year = 3.5473 / (0.146 - 0.08) = 53.75

P0 = ((1.15*1.30)/(1.146)) + ((1.15 * 1.30^2)/(1.146^2)) + ((1.15 * 130^3)/(1.146^3)) + ((1.15 * 1.30^4 + 53.75)/(1.146)^4)
= 37.53

P0 = $37.53

6.

NPV= Present value of cash inflows - cash outflow
= (500/(1+0.114)^1) + (400/(1+0.114)^2) + (300/(1+0.114)^3) + (100/(1+0.114)^4) - 1,000
= 448.83 + 322.32 + 217 + 64.93 - 1,000
= $53.09

NPV = $53.09

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