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# Calculating WACC to Assess Projects

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1. Howard Industries has a target capital structure consisting of 35% debt, 5% preferred stock, and 60% common equity. The-tax YTM on Howard's long term bonds is 9.5% it cost of preferred stock is 8% and its cost of retained earnings is 12.5%. If the firm's 40% what is Howard's WACC if it doesn't have to issue new common stock?

9.33%
9.67%
9.90%
9.56%
8.99%

If they undertake a variety of projects with different levels of risk. Howard adds 2 percentage points to its WACC for high-risk projects and subtracts 2 percentage points from its WACC for low-risk projects.

Which projects should Howard Industries accept check all that should be accepted?

Project Expected rate of return risk accept project
A 10.7% High
B 10.4% Average
C 12.7% High
D 8.5% Low
E 8.6% Average
F 6.7 % Low
G 9.1% Low
H 10.8% Average

2. Capital Structure weights

Frank Inc has the following abridge balance sheet:

Current Assets \$3,600 Debt \$5,200
Preferred stock \$ 600
Fixed assets \$6,400 Common Equity \$ 4,200
Total assets \$10,000 Total liabilities and equity \$10,000

The market value of Franks' debt preferred stock and common equity its book value. Frank's cost of debt is 10% cost of preferred stock is 7.7% and its costs of common equity are 15%. If Frank's tax rate is 30% what is the firm's WACC?

9.65%
10.43%
9.89%
10.49%
9.97%

#### Solution Preview

Please refer attached file for better clarity of calculations.

1.
Weight of debt=wd=35%
Cost of debt=rd=9.50%
Tax Rate=T=40.00%

Weight of prefered stock=wp=5%
Cost of prefered stock=rp=8%

Weight of common equity=wc=60%
Cost of equity=rc=12.50%

WACC=wd*rd*(1-T)+wp*rp+wc*rc=35%*9.5%*(1-40%)+5%*8%+60%*12.5%=9.90%

Expected return on average risk projects should be above 9.90%
Expected return on low risk projects should be above ...

#### Solution Summary

Solution describes the steps to calculate WACC in the given cases, attached in Excel with calculations displayed.

\$2.19

## Helping the CFO analyze net present value

____ 8. After taking into account all of the relevant cash flows from the previous question, the company's CFO has estimated the project's NPV and has also put together the following scenario analysis:

Scenario Prob. of Scenario Occurring Expected NPV
County taxes increased 25% \$ 5 million
County taxes unchanged 50 8 million
County taxes decreased 25 10 million

On the basis of the numbers calculated above, the CFO estimates that the standard deviation of the project's NPV is 2.06. The company typically calculates a project's coefficient of variation (CV) and uses this information to assess the project's risk. Here is the scale that Bruener uses to evaluate project risk:

Range for Coefficient Risk Project's
of Variation (CV) Assessment WACC

CV > 0.3 High risk 12%
0.2<CV<0.3 Average risk 10
CV < 0.2 Low risk 8

On the basis of this scenario analysis, which of the following statements is most correct?
a. The project's expected NPV is \$7.75 million.
b. The project would be classified as an average-risk project.
c. If the project were classified as a high-risk project, the company should go back and recalculate the project's NPV using the higher cost of capital estimate.
d. Statements a and b are correct.
e. All of the statements above are correct.

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