Purchase Solution

# Financial Target Capital Structures

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1) Jackson Company has a target capital structure of 40% debt and 60% common equity. The company's before-tax cost of debt is 12% and its marginal tax rate is 40%. The current stock price is \$22.50; the last dividend was \$2.00 and the dividend is expected to grow at 7%. What will be the firm's cost of common equity and WACC?

2) Orwell Company is considering including two pieces of equipment, a truck and an overhead pulley system in this year's capital budget. The projects are independent. The cash outlay for the truck is \$17,100 and for the pulley system \$22,430. The firm's cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:
Year Truck Pulley
1 \$5,100 \$7,500
2 5,100 7,500
3 5,100 7,500
4 5,100 7,500
5 5,100 7,500

Calculate the IRR, the NPV, and the MIRR for each project and indicate the correct accept/reject decision for each.

3) The Johnson Company is evaluating the proposed acquisition of a new machine. The machine's base price is \$108,000 and it would cost another \$12,500 to modify it for operating purposes. The machine falls into the MACRS 3-year class and it would be sold after 3 years for \$65,000. The machine would require an increase in net working capital of \$5,500. The machine would save the company \$44,000 per year in before-tax operating costs. Johnson's marginal tax rate is 35%. Should the company purchase the machine? Show your calculations.

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The financial target capital structures are examined.

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