1 Northwestern Lumber Products currently has 15,500 shares of stock outstanding.
ID: 2808937 • Letter: 1
Question
1 Northwestern Lumber Products currently has 15,500 shares of stock outstanding. Patricia, the financial manager, is considering issuing $123,000 of debt at an interest rate of 6.2 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the break-even level of EBIT between these two capital structure options is $61,000? Ignore taxes.
(A)12,884.13 shares
(B)12,658.10 shares
(C)14,692.43 shares
(D)13,562.25 shares
(E)11,624.78 shares
2.Alpha Industries is considering a project with an initial cost of $8.6 million. The project will produce cash inflows of $2.04 million per year for 6 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.79 percent and a cost of equity of 11.39 percent. The debt–equity ratio is .66 and the tax rate is 35 percent. What is the net present value of the project?
(A) $758,352
(B) $656,266
(C) $729,185
(D) $625,015
(E) $506,837
Explanation / Answer
1) NI before issue of debt 61000.00 NI when debt is issued = 61000 -123000*6.2% = 53374.00 At break-even level of EBIT the EPS would be the same: Hence, 61000/15500 = 53374/x where, x is the number of shares after debt is issued. x = 53374*15500/61000 = 13562.25 Answer: Option [D] 2) WACC of the of the firm: After tax cost of debt = 5.79*(1-0.35) = 3.76% WACC = 3.76*0.66/1.66+11.39*1/1.66 = 8.36% NPV = 2040000*(1.0836^6-1)/(0.0836*1.0836^6)-8600000 = $ 7,28,559 Nearest answer is Option [C]. Difference is due to rounding off.
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