Compute the company’s WACC

1. The Turnip Company plans to issue preferred stock. Currently, the company’s stock sells for $110. Once new stock is issued, the Turnip Company would receive only $90. The dividend rate is 8%, and the par value of the stock is $100. Compute the cost of capital of the stock to your firm. Show all work.

2. The Maximus Corporation is considering a new investment, which would be financed from debt. Maximus could sell new $1,000 par value bonds at a new price of $920. The bonds would mature in 13 years, and the coupon interest rate is 10%. Compute the after-tax cost of capital to Maximus for bonds, assuming a 34% tax rate. Show work.

3. Connor Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 10%.

Project 1

Project 2

Initial investment

$(465,000)

$(700,000)

Cash inflow Year 1

$510,000

$850,000

Compute the following for each project:

· NPV (net present value)

· PI (profitability index)

· IRR (internal rate of return)

Based on your analysis, answer the following questions :

· Which is the best choice? Why?

· Which project should be selected and why? If the projects had the same IRR amounts but different NPV totals, then how would you know which project to select? Explain.

· What would happen if both projects had negative NPV totals? Which project would you choose? What do negative NPVs indicate? Explain.

· Should we also use the payback method to assist us in project selection? Why or why not? Explain.

4. The capital structure for Magellan Corporation is shown below. Currently, flotation costs are 13% of market value for a new bond issue and $3 per share for preferred stock. The dividends for common stock were $2.50 last year and have an estimated annual growth rate of 6%. Market prices are $1,020 for bonds, $20 for preferred stock, and $30 for common stock. Assume a 34% tax rate.

Financing Type

% of Future

Financing

Bonds (8%, $1k par, 16 year maturity)

36%

Common equity

45%

Preferred stock (5k shares outstanding, $50 par, $1.50 dividend)

19%

Total %

100%

Compute the company’s WACC. Is this WACC considered reasonable given the assumptions and other relevant information? Explain.

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