Question

round to 4 decimal places and answer them all pleaseeeee

23

Caspian Sea Drinks' is financed with 68.00% equity and the remainder in debt. They have 11.00-year, semi-annual pay, 5.78% coupon bonds which sell for 97.07% of par. Their stock currently has a market value of $25.15 and Mr. Bensen believes the market estimates that dividends will grow at 3.48% forever. Next year’s dividend is projected to be $2.16. Assuming a marginal tax rate of 28.00%, what is their WACC (weighted average cost of capital)?

#2 Caspian Sea Drinks is considering the purchase of a plum juicer – the PJX5. There is no planned increase in production. The PJX5 will reduce costs by squeezing more juice from each plum and doing so in a more efficient manner. Mr. Bensen gave Derek the following information. What is the NPV of the PJX5?

a. The PJX5 will cost $1.92 million fully installed and has a 10 year life. It will be depreciated to a book value of $233,086.00 and sold for that amount in year 10.

b. The Engineering Department spent $40,415.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $16,819.00.

d. The PJX5 will reduce operating costs by $325,548.00 per year.

e. CSD’s marginal tax rate is 36.00%.

f. CSD is 62.00% equity-financed.

g. CSD’s 18.00-year, semi-annual pay, 5.56% coupon bond sells for $1,043.00.

h. CSD’s stock currently has a market value of $23.40 and Mr. Bensen believes the market estimates that dividends will grow at 2.92% forever. Next year’s dividend is projected to be $1.46.

#3 A firm issues preferred stock with a dividend of $4.69. If the appropriate discount rate is 7.76% what is the value of the preferred stock?

#4 A firm will pay a dividend of $3.10 next year. The dividend is expected to grow at a constant rate of 3.25% forever and the required rate of return is 13.88%. What is the value of the stock?

Answer 1

Solution to the First Question

After-tax Cost of Debt

The After-tax Cost of Debt is the after-tax Yield to maturity of the Bond

• The Yield to maturity of (YTM) of the Bond is the discount rate at which the Bond’s price equals to the present value of the coupon payments plus the present value of the Face Value/Par Value
• The Yield to maturity of (YTM) of the Bond is the estimated annual rate of return expected by the bondholders for the bond assuming that the they hold the Bonds until it’s maturity period/date.
• The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Par Value/Face Value of the Bond [$1,000]	FV	1,000
Coupon Amount [$1,000 x 5.78% x ½]	PMT	28.90
Market Interest Rate or Yield to maturity on the Bond	1/Y	?
Maturity Period/Time to Maturity [11 Years x 2]	N	22
Bond Price [-$970.70]	PV	-970.70

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get semi-annual yield to maturity (YTM) on the bond = 3.075%.

The semi-annual Yield to maturity = 3.075%.

Therefore, the annual Yield to Maturity of the Bond = 6.15% [3.075% x 2]

The firm’s after-tax cost of debt on the Bond is the after-tax Yield to maturity (YTM)

The After-tax cost of debt = Yield to maturity on the bond x (1 – Tax Rate)

= 6.15% x (1 – 0.28)

= 6.15% x 0.72

= 4.43%

Cost of Equity

Cost of Equity Discounted Cash Flow Approach

Dividend in year 1 (D1) = $2.16 per share

Current selling price per share (P0) = $25.15 per share

Dividend growth Rate (g) = 3.48% per year

Therefore, the Cost of Common Equity = [D1 / P0] + g

= [$2.16 / $25.15] + 0.0348

= 0.0859 + 0.0348

= 0.1207 or

= 12.07%

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [4.43% x 0.32] + [12.07% x 0.68]

= 1.42% + 8.21%

= 9.63%

“Hence, the Weighted Average Cost of Capital (WACC) will be 9.63%”