Question

Question B

Please Answer Part B

Part A
The common stock of Conservation & Construction, Inc. (CCI) has a beta of .8. The Treasury bill rate is 4% and the market risk premium is estimated at 7%. CCI’s capital structure is 30% debt paying a 5% interest rate, and 70% equity.
Required: What is CCI’s cost of equity capital and WACC? Assume CCl’s tax rate is 35%.

r_{e} = r_{f} + \beta *(r_{m} - r_{f})

r_{e} = 0.04 + 0.8 *0.07

r_{e} =0.096 = 9.6\%

WACC = w_{d}*r_{d}*(1-t) + w_{e}*r_{e}

WACC = 0.3*0.05*(1-0.35) + 0.7*0.096

WACC = 0.07695 = 7.695\%

Part B
CCI is evaluating a project with an internal rate of return of 12%.
Required: Based on the data given and your computations in part A, should CCI accept the project? If the project will generate a cash flow of $100,000 per year for 7 years, what is the most CCI should be willing to pay to initiate the project?

Answer 1

WACC = 7.695%

IRR = 12% (Based solely on IRR, the company should accept the project as the IRR is greater than WACC.)

NPV: I = 7.695%; N = 7; PMT = 100,000, solve for PV. PV = 526,112.35

So, PV of expected cash inflows from the project is 526,112.35

This is the most that the company should be willing to pay as an investment equal to this amount will make the project NPV zero.