There are three questions attached here. The following is question three.
Assume that Alnser Company has a project under consideration that requires an initial investment of 1,000,000 QR and will produce incremental after tax cash flows of 350,00 annually for five years.
Alnser company decides to get the money fro the initial investment as follows:
Common Stock 400,000
Preferred Stock 300,000
If you know that:
1. The market risk premium is 8.5%, the risk free rate is 7% and Alnser company has equal to 1.35
2. Alnser Company has a preferred stock which pays an annual dividend of 3.25 QR per share and currently has a market price of 25 QR per share
3. Alnser Company issued a 25 year bond with a 10% coupon and 1,000 face value, the market value of the bond is 915 QR. (Assume the tax rate is 34%).
Based on data given above answer the following questions:
1. Using the SML - CAPM- to compute the firm's cost of Equity.
2. Compute the cost of Preferred stock
3. Computer the cost of Debt after tax
4. Compute the Weighted Average Cost of Capital (WACC).
5. Compute the NPV.
See attachment for clearer view.
The loan amortization is in the attached Excel file.
Question One: Solution" WACC and NPV
a. Cost of Equity (using CAPM)
Cost of Equity = Risk Free Rate + [beta x (market risk premium)]
= 7.0% + (1.35 x 8.5%)
b. Cost of Preferred Stock = Dividend/Price of Stock
$3.25/$25 = .13 or 13 %
c. Cost of Debt = Face Value $1000; Current market value $915; Life 25 years; Coupon 10%; Tax Rate 34%
Before Tax Cost of Debt = [$100 + ($1000 " 915)/25]/[(915 + 1000)/2]
= 103.4/957.5 = 0.1080 or 10.8%
After-Tax Cost of Debt = 10.8% (1?" 0.34) = 7.128 %
d. Weights Average Cost of Capital
Common Stock $400,000 = 400,000/1,000,000 = 0.40
Preferred Stock $300,000 = 0.30
Debt $300,000 = 0.30
Apply the Weights to the costs
Common Stock = .4 x 18.475% = 7.39%
Preferred Stock = 0.3 x 13% = 3.9
Debt = 0.3 x 7.128% = 2.14
Initial Outflow $1,000,000
This solution includes the answers for three Financial Management questions that tackle various subjects. Included in the solution is the calculation of a firm's Cost of Equity using the CAPM model; the computation of the Cost of Preferred Stock and the Cost of Debt all leading to the calculation of the Weighted Average Cost of Capital (WACC). The solution also shows how to create an amortization schedule for a mortgage using excel (on a monthly basis and on an annual basis).
Finally, the solution teaches how to decide whether a long-term project is viable using the following techniques:
a. Payback Period
b. Net Present Value (NPV)
c. Profitability Index (PI)
d. Internal Rate of Return (IRR)