The Cost of Capital,And ,The Basics of Capital Budgeting: Evaluating Cash Flows,,Problem 1,You are employed by ABC Inc. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT.,,Assets,Current assets $30,000,000,Net plant, property, and equipment $100,000,000,,Total Assets $130,000,000,,,Liabilities and Equity ,Accounts payable $10,000,000,Accruals $10,000,000,Current liabilities $20,000,000,,Long term debt (40,000 bonds, $1,000 face value) $40,000,000,Total liabilities $60,000,000,,Preferred Stock (100,000 shares, $100 face value) $10,000,000, ,Common Stock (10,000,000 shares) $30,000,000,Retained Earnings $30,000,000,Total shareholders equity $70,000,000,,Total liabilities and shareholders equity $130,000,000,,You check The Wall Street Journal and see that ABC stock is currently selling for $10.00 per share and that ABC bonds are selling for $1100.0 per bond. These bonds have a 7 percent coupon rate, with semi-annual payments. The bonds mature in twelve years. The preferred stock has an unlimited life and pays an 5 percent annual coupon. The preferred stock sells for $95. The beta for your company is approximately equal to 2. The yield on a 20-year Treasury bond is 4.0 percent. The expected return on the stock market is 8.0 percent. ABC is in the 40 percent tax bracket. ,,,,,2. Davis Corporation is faced with two independent investment opportunities. The corporation has an investment policy which requires acceptable projects to recover all costs within 3 years. The cost of capital is 10 percent. The cash flows for the two projects are:,, Project A Project B , Year Cash Flow Cash Flow , 0 -$120,000 -$90,000 , 1 42,000 30,000 , 2 43,000 30,000 , 3 44,000 30,000 , 4 45,000 30,000, 5 46,000 30,000,,Which investment project(s) does the company invest in using the:,,1) Payback period rule,2) Discounted payback period rule,3) NPV,4) IRR,,3. XYZ Corporation is faced with two mutually exclusive investment opportunities. The cost of capital is 12 percent. The cash flows for the two projects are:,, Project A Project B , Year Cash Flow Cash Flow , 0 -$140,000 -$100,000 , 1 60,000 30,000 , 2 60,000 30,000 , 3 60,000 30,000 , 4 30,000 , 5 30,000, 6 30,000,Which investment project should the company invest in using the:,,1. Equivalent annual annuity approach,2. The replacement approach,,
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