1. B plc is a hot air balloon manufacturer whose equity:debt ratio is 5:2. The c
ID: 2807189 • Letter: 1
Question
1. B plc is a hot air balloon manufacturer whose equity:debt ratio is 5:2. The company is considering a waterbed-manufacturing project. B plc will finance the project to maintain its existing capital structure S plc is a waterbed-manufacturing company. It has an equity beta of 1.59 and a Ve:Vd ratio of 2:1. The yield on B plc's debt, which is assumed to be risk free, is 11%. B plc's equity beta is 1.10. The average return on the stock market is 16%. J The corporation tax rate is 30% Required: Calculate a suitable cost of capital to apply to the project. 2. A project requires an initial investment of $20,000 and will generate annual cash flows as follows: YearCash flow $ 4,000 (2,000) 6,000 7,600 10,000 4 The firm's financing rate (for negative cash flows) is 9%. and its j reinvestment rate for positive cash flows is 6% Required: What is the MIRR?Explanation / Answer
Solution 1
Weight of equity (We) = 5/(5+2)
= 0.7143
Weight of Debt (Wd) = 2/(5+2)
= 0.2857
Cost of debt (Rd) = 11%
Cost of equity (Re) = Rf + (Rm- Rf) x Beta
= 0.11 + (0.16 -0.11) x 1.10
= 0.11 + 0.055
= 16.50%
WACC = Wd x Rd x (1-t) + We x Re
= 0.2857 x 0.11 x (1-0.30) + 0.7143 x 0.1650
= 0.022 + 0.1179
= 13.99%
Therefore, weighted average cost of capital would be 13.99%.
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