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Given the following data for El Pollo Loco Inc:
a) Calculate its weighted average cost of capital (WACC).

Percent of capital structure:
Debt 35%
Preferred stock 10%
Common equity 55%
Additional Information:
Bond coupon rate 11%
Bond yield to maturity 9%
Dividend, expected common $ 2.50
Dividend, preferred $ 7.00
Price, common $ 45.00
Price preferred $ 100.00
Flotation costs, preferred $ 5.00
Growth rate 8%
Corporate tax rate 35%

b) What would be the WACC if the tax corporate rate increases to 45%?
c) What are the implications of the changes in part B) for investing in capital projects?

2. â?" In general terms, why is the effective cost (cost to company) of debt less than the cost of common stock if both securities were priced to yield (return to the investor) 10 percent in the market?

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Solution Preview

Given the following data for El Pollo Loco Inc:

a) Calculate its weighted average cost of capital (WACC).

Percent of capital structure:
Debt 35%
Preferred stock 10%
Common equity 55%
Additional Information:
Bond coupon rate 11%
Bond yield to maturity 9%
Dividend, expected common $2.50
Dividend, preferred $7.00
Price, common $45.00
Price preferred $100.00
Flotation costs, preferred $5.00
Growth rate 8%
Corporate tax rate 35%

Cost of debt = bond yield to maturity = 9%
After-tax cost of ...

Solution Summary

This solution is comprised of a detailed explanation to calculate its weighted average cost of capital (WACC).

$2.19
See Also This Related BrainMass Solution

Finance Case: Calculate WACC, NPV, PI, IRR and MIRR

See also enclosed Word document of the case study and excel spreadsheet for the financial exibit. Please help answer all questions.

The Investment Detective

The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm's capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenges is knowing what quantitative analysis to generate in the first place.

Supposed you are a new capital budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the "four best" that the company should accept.

Part I

For the first part of this assignment only quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.
All projects require the same initial investment, $2,000,000. Moreover, all are believed to be of the same risk class. The weighted average cost of capital for the first part is 10%. To simulate your analysis, consider the following questions:

1. Can you rank the projects simply by inspecting the cash flows?
2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?
3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?
4. What kinds of real investment projects have cash flows similar to those in the exhibit?

Part II
The company has the following capital structure:
Account $ Costs before tax
Long-term Debt 2,000,000 10%
Preferred Stock 500,000 14%
Common Stock 2,500,000 16%

1. Calculate the weighted average cost of capital (tax is 36%)
2. Using the same cash flows in exhibit I, find the NPV, PI, IRR and MIRR. Which project(s) would you recommend and why?

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