7)Suppose that TipsNToes, Inc.\'s capital structure features 40 percent equity,

Question

7)Suppose that TipsNToes, Inc.'s capital structure features 40 percent equity, 60 percent debt, and that its before-tax cost of debt is 9 percent, while its cost of equity is 15 percent. If the appropriate tax rate is 25 percent, what will be TipsNToes's WACC?

8)Suppose you sell a fixed asset for $50,000 when its book value is $60,000. If your company's marginal tax rate is 40%, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

9)Your company has spent $500,000 on research to develop a new computer game. The firm is planning to spend $100,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $5,000. The machine has an expected life of 3 years, a $100,000 estimated resale value, and falls under the MACRS 5-Year class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 10 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will be the net cash flow for year one of this project?

Sales $500,000

Fixed Costs - 200,000

Depreciation - 21,000

EBIT $279,000

Taxes - 97,650

Net Income $181,350

Depreciation 21,000

Cash Flow $202,350

Explanation / Answer

7)

WACC = Wd×Rd×(1-t)+ We×Ke

W is weights of respective portfolios

R is return on respective portfolios

WACC = 0.60×9%×(1-25%)+ 0.40×15%

= 10.05%

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