Problem 1. Sangria Corporation has a marginal tax rate of 35%. The cost of equity is 14.6% and the pretax cost of debt is 8%. Given the book and market value balance sheets shown below, what is the tax adjusted WACC?
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Balance Sheet (Book Value, Millions)
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Assets
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125
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50
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Debt
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75
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Equity
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Total Assets
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125
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125
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Total
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Problem 2: Company ABC had only $277 million in debt on its books in March 1990, while the market value of equity at the same point in time was $16,182 million (the market price per share was $69.75 and there were 232 million shares outstanding). In proportional terms, 1.68% of the overall financial mix was debt and the remaining 98.32% was equity.
The beta for Company ABC’s stock in March 1990 was 0.95. The Treasury bond rate at that time was 9.00%. Company ABC’s senior debt rate was AA. While Company ABC had no bonds outstanding, other long-term bonds with AA rating were yielding 9.70%. The tax rate was 34%.
a. Calculate the value of the firm in March 1990
b. Calculate the cost of equity
c. Calculate the cost of debt
d. Calculate the weighted average cost of capital
Problem 3: Consider a project requiring an investment of $20,000 that is expected to return, in actual dollars, $6,000 at the end of the ?rst year, $8,000 at the end of the second year, and $12,000 at the end of the third year. The general price in?ation rate is 5% per year, and the real interest rate is 10% per year. Compare the PW of this project using before-tax actual dollar and real dollar analysis (assume).
Problem 4: The XYZ Corporation has an overhead crane that has an estimated remaining life of 10 years. The crane can be sold now for $8,000. If the crane is kept in service, it must be overhauled immediately at a cost of $4,000. Operating and maintenance costs will be $3,000 per year after the crane is overhauled. The overhauled crane will have zero market value at that time. Operating and maintenance costs are $1,000 per year for the new crane. The company uses a before-tax interest rate of 10% per year in evaluating investment alternatives. Conduct a before-tax replacement analysis and state whether the company should replace the old crane?