Fin 534 Week 8 Homework Assignment Set 4

Running Head: COST OF CAPITAL-BASICS OF CAPITAL BUDEGETING (CASH FLOWS) – ESTIMATION AND RISK ANALYSIS 2A. Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees a growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital?The below computation of Cost of equity was done using the dividend growth model WEIGHTAGECOSTTAX RATEAFTER TAX COST New Debt45%8%35%5.20 %Preferred Stock5%10%Non-Tax DeductibleCommon Stock50%12.50%Non-Tax DeductibleCost of Capital =(45% X 5.2%) +(5%X10%)+(50% X 12.50%)=9.09 %B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common

Homework set 4: Assume you are presented with the following mutually exclusive investments whose expected net cash Fows are as follows: EXPECTED NET CASH ±LOWS: Year Project A Project B0-$400-$650 1-528 210 2-219 210 3-150 210 4 1100 210 5 820 210 6 990 210 7-325 210 1A. What is each project’s IRR? Project A IRR = 21% Project B IRR = 26% 1B. If each project’s cost of capital were 10%, which project, if either, should be selected? If the cost of capital were 17%, what would be the proper choice? Discount rate NPV Project A NPV project B 10% $478.83 $372.37 17% $133.76 $173.70 By using a 10% discount rate I will select Project A as having a higher NPV and by using 17% discount rate I would select Project B. 2. What is each project’s MIRR at the cost of capital of 10%? At 17%? (Hint: Consider Period 7 as the end of Project B’s life.) Discount rate project A MIRR project B MIRR 10% 15% 17% 17% 19% 21%

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