Question

You have the following information about Burgundy Basins, a sink manufacturer.

Equity shares outstanding		20	million
Stock price per share	$	30
Yield to maturity on debt		7.5	%
Book value of interest-bearing debt	$	320	million
Coupon interest rate on debt		3.5	%
Market value of debt	$	200	million
Book value of equity	$	320	million
Cost of equity capital		10.0	%
Tax rate		35	%

Burgundy is contemplating what for the company is an average-risk investment costing $20 million and promising an annual ATCF of $4.0 million in perpetuity.

a. What is the internal rate of return on the investment? (Round your answer to 2 decimal places.)

b. What is Burgundy's weighted-average cost of capital? (Round your answer to 2 decimal places.)

Answer 1

	a) computation of Internal rate of return (IRR)
	IRR is the discount rate at which Net Present Value (NPV) is zero.
	Present Value of perpetuity is simply C/r, wherein C is the same cash flow every year and r is the discount rate.
	If we equate this Present Value to the initial investment, then the NPV becomes zero, and, thus, the r comes to be known as IRR.
	Thus, simply, IRR=C/initial investment
	IRR=0.4/20
	IRR= 2%
	b) Computation of weighted average cost of capital ('WACC')
	The WACC can be computed by taking book value of weight or market value of weight
	Computation of WACC by taking market value of weigh
	Capital	Amount ($)	Rates	Tax impact	Rates after tax	Weight	WACC
	Market value of equity shares	600	10		10	0.75	7.50
	Market value of interest bearing debt	200	7.5	2.625	4.875	0.25	1.22
	Total	800				1	8.72
	Computation of WACC by taking book value of weigh
	Capital	Amount ($)	Rates	Tax impact	Rates after tax	Weight	WACC
	Book Value of equity shares	320	10	0	10	0.5	5.00
	Book value of interest bearing debt	320	7.5	2.625	4.875	0.5	2.44
		640				1	7.44
	Market value of equity shares
	No of equity shares (in million)	20
	Market value of shares ($)	30
	Market value of Equity share capital	600