Problem 2. S & P Corporation (SPC) has a constant growth rate of 5.0% and retains 20% of its earnings to fund future growth. The company currently has a capital structure that consists in 20% debt and 80% equity, its marginal tax rate is 40% and its current beta is 1.265 (this is a levered beta). You check the Wall Street Journal and find that T-bond yield (the risk free rate) is 4.0% and the market risk premium is 5.5%. In a separate sheet, complete the Table below (hint: you need to find the unlevered beta first and then use it to find levered betas). Debt/Total Assets (%) Expected EPS Beta Rs Po 20 $ 3.00 1.265 10.96% $40.29 30 $ 3.50 ? ? ? 40 $ 4.00 ? ? ? 50 $ 4.50 1.760 13.68% $41.47 60 $ 5.00 2.090 15.50% $38.11 a) What is the optimal capital structure? b) What is the required return of equity at the optimal capital structure? c) What is the stock price at the optimal capital structure? Problem 3. S & P Corporation (SPC) has determined that its optimal capital structure consists of 40% debt and 60% equity. Given the following information, calculate the firm's weighted average cost of capital. ô°€ 5 years ago, the company issued non-callable bonds that pays semiannual payment with 5.5% annual coupon rate and sold them at par value ($1,000). However, each bond is currently selling at $902.32 and has 16 years remaining to maturity. â€¨ ô°€ Tax rate is 40%. â€¨ ô°€ The SPCâ€™s beta is 1.540. Assume that the market risk free rate is 4.0% and the market risk premium is â€¨5.5%. â€¨ ô°€ SPCâ€™s current stock price is $42.84, its growth rate is 5.0% and its expected earnings per share (EPS1) is 4.0. The company retains 20% of its earnings to fund future growth. â€¨ Calculate: . a) Cost of debt â€¨ . b) Cost of equity using the CAPM approach â€¨ . c) Cost of equity using the DCF approach â€¨ . d) Weighted average cost of capital (WACC) â€¨ Problem 4. S & P Corporation (SPC) is considering entering a new line of business. In analyzing the potential business, the financial staff has accumulated the following information: ô°€ The new business will require a capital expenditure of $4.5 million at t = 0. This expenditure will be used to purchase new equipment. â€¨ ô°€ This equipment will be depreciated according to the following depreciation schedule: â€¨MACRS Depreciation â€¨ Year Rates MACRS Depreciation Rates 1 0.20 â€¨ 2 0.32 â€¨ 3 0.19 â€¨ 4 0.12 â€¨ 5 0.11 â€¨ 6 0.06 â€¨ ô°€ The equipment will have no salvage value after five years. â€¨ ô°€ If SPC goes ahead with the new business, inventories will rise by $300,000 at t = 0, and its accounts payable will rise by $200,000 at t = 0. This increase in net operating working capital will be recovered at t =5. â€¨ ô°€ The new business is expected to have an economic life of five years. The business is expected to generate sales of $3 million at t = 1, $4 million at t = 2, and $5 million per year for the remainder of the economic life. Each year, operating costs excluding depreciation are expected to be 55% of sales. â€¨ ô°€ The companyâ€™s tax rate is 40%. â€¨ ô°€ The company's interest expense each year will be $100,000. â€¨ ô°€ The company is very profitable, so any accounting losses on this project can be used to reduce the companyâ€™s overall tax burden. â€¨ ô°€ The companyâ€™s overall WACC is 9.04%. However, the proposed project is riskier than the average project for SPC and you are asked to add 2% to the WACC when calculating NVP. â€¨ *****Calculate NPV, IRR and payback period, and write a short memo to Dr. Sanchez â€“ SPC Chief Financial Officerâ€“ recommending or not entering new business line. Explain your recommendation. â€¨Problem 5. Tesar Chemicals is considering Projects A and B, whose Net Present Values (S million) at different levels of WACC and Internal Rate of return are shown below. Which project(s) would you recommend to be accepted if they were mutually exclusive projects? Explain. â€¨ NPV@ 5% NPV@ 10% NPV@ 15% IRR A 3.52 0.58 -1.91 11.10% B 2.87 1.04 -0.55 13.18%

Subject | Business |

Due By (Pacific Time) | 12/16/2014 01:00 pm |

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