Question

1. Determine the weighted average cost of capital (WACC) for each of the

   Table 1                                 Pacific Technology COMPANY
   Balance Sheet 12/31/2005
   Assets		Liability & Equity
   Cash	$6,000,000	Account Payable	$1,000,000
   Account Receivable	$8,000,000	Notes Payable	$3,000,000
   Inventory	$3,000,000	Accrued Taxes	$1,000,000
   Current Asset	$17,000,000	Current Liabilities	$5,000,000
   GFA	$40,000,000	Long-term debt	$10,000,000
   Accumulated Depreciation	($2,000,000)	Preferred Stock (0.5 million shares)	$15,000,000
   Net Fixed Assets	$38,000,000	Common Stock (1 million shares)	$10,000,000
   		Returned Earnings	$15,000,000
   		Common Equity	$25,000,000
   Total Asst	$55,000,000	Total Liability & Equity	$55,000,000

   Table 2 -Income Statement (12/31/2005)
   Sales	$25,000,000
   Cost of Sales	-8,500,000
   Earnings Before Depreciation and Amortization (EBITDA)	$16,500,000
   Depreciation	-1,550,000
   Earnings Before Interest and taxes (EBIT)	$14,950,000
   Interest Expense	($950,000)
   Taxable Income	$14,000,000
   Taxes (40%)	($5,600,000)
   Net Income	$8,400,000

              

   Its established common stock’s dividend payout ratio after the preferred stock dividends payment is 50 percent and it is expected to grow at a constant rate of 9 percent in the future. The tax rate is 40 percent and investors requiring a rate of return of 15% on the common stock.

   Preferred stock is trading at a price of $40 per share, with a dividend of $4.8. The 30-year long-term debt with a par value of $1,000 was issued 10 years ago with a coupon rate of 8%. The bonds can be refinanced at the market interest rate of 10 percent today.

   Pacific Technology has the following investment opportunities:

   Table 3	Project	Annual Net
   Project	Cost	Cash Flow	Life
   Defense 1	$1,000,000	$219,120	7
   Defense 2	$2,000,000	368,580	10
   Eng. Materials 1	$1,000,000	222,851	8
   Eng. Materials 2	$2,000,000	542,784	6
   Communication and Space 1	$1,000,000	202168	9
   Communication and Space 2	$1,000,000	319,775	5

   capital structure.

Answer 1

Calculating WACC

cost of debt (Kd): 8% (given as 8% coupon rate)

cost of preferred shares (Kp): (4.8/40)*100% = 12% (preferred share dividend as a percentage of preferred share price)

cost of common stock (Ke): 15% (investors require RoR of 15%)

Value of debt: $10,000,000 (from Balance Sheet)

Value of preferred shares: $15,000,000 (from Balance Sheet)

Value of commong equity: $25,000,000 (from Balance Sheet)

WACC:

(Kd*Debt + Kp*Preferred shares value + Ke*common equity value)/(Debt + Preferred shares value + common equity value)

(8%*10,000,000 + 12%*15,000,000 + 15%*25,000,000)/(10,000,000+15,000,000+25,000,000) = 12.7%