Case Scenario:
Rollins Corporation is estimating its WACC. It's current and target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon rate, paid semiannually, a current maturity of 20 years, and sell for $1,040. The firm could sell, at par, $100 preferred stock which pays a $12.00 annual preferred dividend. Rollins' common stock beta is 1.2, and the risk-free rate is 10 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00. Its stock sells for $27.00 per share, and has a growth rate of 3 percent. The floatation cost is 5% for debt, 10% for preferred stock, and 25% for common stock. The firm's marginal tax rate is 40 percent.
Question 1:
Part a. Calculate the cost of existing debt.
Part b. Calculate the cost of new debt.
Question 2:
Part a. Calculate the cost of existing preferred stock.
Part b. Calculate the cost of new preferred stock.
Question 3:
Part a. Calculate the cost of existing common stock.
Part b. Calculate the cost of new common stock.
Question 4:
Part a. Calculate the weighted average cost of capital (WACC) for existing capital
Part b. Calculate the weighted average cost of capital (WACC) for new capital
Question 5:
Given that the company's required return (WACC) is 10%, rank the two following projects:
Use only one best method to rank the projects
Project A B
Project life 12 years 12 years
Initial investment $1,200,000 $1,500,000
Annual operating cash flows $180,000 $225,000
Question 6:
Foley Systems is considering a new investment whose data are shown below. The equipment would be depreciated using the MCRS system basis over the project's 4-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's life. What is the project's NPV?
NOTE: The depreciation system used in the US is MACRS which stands for Modified Accelerated Cost Recovery System. Some people refer to it as accelerated to distinguish it from the straight line depreciation.
The accelerated rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4.
WACC 10.0%
Net initial investment in fixed assets $75,000
Required new working capital $15,000
Sales revenues, each year $75,000
Operating costs (excluding depreciation), each year $25,000
Tax rate 35.0%