1. Cost of Common Equity with and without Flotation The Evanec Company\'s next e
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Question
1. Cost of Common Equity with and without Flotation
The Evanec Company's next expected dividend, D1, is $3.17; its growth rate is 6%; and its common stock now sells for $34. New stock (external equity) can be sold to net $28.90 per share.
What is Evanec's cost of retained earnings, rs? Round your answer to two decimal places.
rs = ____%
What is Evanec's percentage flotation cost, F? Round your answer to two decimal places.
F = ______%
What is Evanec's cost of new common stock, re? Round your answer to two decimal places.
re = ____%
2. WACC
The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 8.6 million shares outstanding, is now (1/1/15) selling for $76 per share. The expected dividend at the end of the current year (12/31/15) is 65% of the 2014 EPS. Because investors expect past trends to continue, g may be based on the historical earnings growth rate. (Note that 9 years of growth are reflected in the 10 years of data.)
The current interest rate on new debt is 8%; Foust's marginal tax rate is 40%; and its target capital structure is 35% debt and 65% equity.
Calculate Foust's after-tax cost of debt. Round your answer to two decimal places.
_____%
Calculate Foust's cost of common equity. Calculate the cost of equity as rs = D1/P0 + g. Round your answer to two decimal places.
_____%
Find Foust's WACC. Round your answer to two decimal places.
_____ %
3.
Project cash flow
Eisenhower Communications is trying to estimate the first-year net operating cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:
The company has a 40% tax rate, and its WACC is 12%.
Write out your answers completely. For example, 13 million should be entered as 13,000,000.
What is the project's operating cash flow for the first year (t = 1)? Round your answer to the nearest cent.
$ ______
If this project would cannibalize other projects by $2.5 million of cash flow before taxes per year, how would this change your answer to part a? Round your answer to the nearest cent.
The firm's OCF would now be $ _____
Ignore Part b. If the tax rate dropped to 35%, how would that change your answer to part a? Round your answer to the nearest cent.
The firm's operating cash flow would increase or decrease Item by $ ____
4.
New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $280,000, and it would cost another $42,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $126,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $13,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $44,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$ ______
What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.
in Year 1 $ ____
in Year 2 $ ____
in Year 3 $ ____
Explanation / Answer
1. Cost of Common Equity with and without Flotation
The Evanec Company's next expected dividend, D1, is $3.17; its growth rate is 6%; and its common stock now sells for $34. New stock (external equity) can be sold to net $28.90 per share.
What is Evanec's cost of retained earnings, rs? Round your answer to two decimal places.
rs = D1/Current Stock Price + growth rate
rs = 3.17/34 + 6%
rs = 15.32%
Answer
rs = 15.32 %
What is Evanec's percentage flotation cost, F? Round your answer to two decimal places.
F = (Current Price - Net Price of new equity)/ Current Price
F = (34 - 28.90)/34
F = 15%
Answer
F = 15 %
What is Evanec's cost of new common stock, re? Round your answer to two decimal places.
re = D1/Net Current Stock Price + growth rate
re = 3.17/28.90 + 6%
re = 16.97%
Answer
re = 16.97%
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