Question

Part 4: Capital Budgeting Chp B 8. Worldwide Widget Manufacturing, Inc., is preparing to launch a new Manufacturing, Inc., is preparing to launch a new manufacturing y in a new location. The company has a capital structure that consists of debt and common and preferred stock. The company is considering changing this capi- al structure in conjunction with the launch of the new manufacturing facility. The manufacturing facility project is slated to be funded with 30 percent debt, 30 percent preferred stock, and 40 percent common stock. Worldwide Widget Manufacturing nas 15 million shares of common stock outstanding. The shares sell at $24.63 per share. The company expects to pay an annual dividend of $1.50 one year from now, after which future dividends are expected to grow at a constant 7 percent rate. Worldwide Widget Manufacturina's debt consists of 30-year 9-percent annual cou- pon bonds with a face value of $180 million and a market value of $185 million. The company's capital mix also includes 200.000 shares of 12-percent preferred stock trading at par. If Worldwide Widget Manufacturing has a marginal tax rate of 32 per- cent, what weighted average cost of capital (WACC) should it use as it evaluates this project? 9. Worldwide Widget Manufacturing, Inc., wants to add two new production lines of widgets. You're asked to analyze whether to go forward with two mutually exclusive projects. The cash flows of both projects are displayed below. Your company uses a cost of capital of 9 percent to evaluate projects such as the two you're now analyzing. Show all calculations. Year: -$1,000 1 $150 $300 Proiect A Cash Flow Project B Cash Flow 2 $300 $470 3 $500 $500 $200 4 $300 $800 $800 $250 -$1,400 $350 Calculate the payback of Project A: (890) abnova (9V) le too Calculate the payback of Project B: (SVM) 10 M Calculate the IRR of Project A: Calculate the IRR of Project B: alos no solo Laina the NPV method and assuming a cost of capital of 6 percent, calculate the NPV of these two projects. Which of these mutually exclusive projects should the company accept? TOS 101 129 sinis 10S 10 ST TOS 101 (293) nara 20 animea LOS 10 (890) og bebivio atosto (9) r uloom

Answer 1

Step 01 :

Cost of Equity (Re) = (D1/P0) + g =

Next Year Dividend , D1 = 1.50

g = Futture Dividend growth rate = 7% = 0.07

P0 = Current Share Price = 24.63

Cost of Equity (Re) = ( 1.50/ 24.63) + 0.07 = 0.1309

Step 02 :

Cost of Debt (Rd) = YTM of its Bond

  $= \frac{C +\frac{ F - P}{N}}{\frac{F+P}{2}}$

Here C = Coupon Payment = 9% of Face Value 180 = 9% * 180 = 16.20

F = Face Value of Bond = 180

P = Market Value of Bond = 185

N = Outstanding Period = 30 Years

So Rd

$= \frac{16.2 +\frac{ 180 - 185}{30}}{\frac{180+185}{2}}$

= 0.087854  

Step 03 :

Cost of Preffered Share (Rs) = Annual Interest Payment = 12% = 0.12

Step 04 :

WACC = We * Re + Wd * Rd * (1 - T) + Ws * Rs

Weight of Equity We = 0.40 (Common Stock)

  Weight of Debt Wd = 0.30

  Weight of Preffered Share Ws = 0.30

Tax Rate T = 32% = 0.32

WACC = 0.40 *  0.1309 + 0.30 * 0.087854 * (1 -  0.320) +  0.30 * 0.12 = 0.05236 + 0.01792 + 0.0360 = 0.10628 = 10.628%

WACC it should use to re-evaluate its project should be = 10.628% (Ans)