Question

Project L requires an initial outlay at t = 0 of $62,000, its expected cash inflows are $15,000 per year for 8 years, and its WACC is 10%. What is the project's payback? Round your answer to two decimal places.

  years

Pearson Motors has a target capital structure of 35% debt and 65% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 9%, and its tax rate is 25%. Pearson's CFO estimates that the company's WACC is 12.60%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

  %

Answer 1

Question 1:

Payback period is the number of years required to re-earn the invested cash flows.

Invested Cash Flow = $62,000

Cash Inflow per year = $15,000.

Cash inflow for 4 years = 4 * $15,000 = $60,000

Amount required in year 5 to complete payback = $62,000 - $60,000 = $2,000

Hence, fraction of year 5 = $2,000/$15,000 = 0.13 year

Payback = 4 + 0.13 years = 4.13 years

Question 2:

WACC = Weight of debt * Pretax cost of debt * (1 - Tax) + Weight of Equity * Cost of Equity

12.60% = 35% * 9% * (1 - 25%) + 65% * Cost of Equity

12.60% = 2.3625% + 65% * Cost of Equity

10.2375% = 65% * Cost of Equity

Cost of Equity = 15.75%