Question 1: Discuss in detail how shareholders are impacted by a corporation’s acceptance of both positive and negative NPV projects. How is share price related to capital budgeting management? In your response, mention specifically how share price and NPV are related.
Question 2: Longhorn Corporation is a startup company that wishes to calculate its weighted average cost of capital. You have been hired to perform this work, and the CFO has provided the following facts relative to it:
|
Debt Ratio
|
Equity Ratio
|
Debt Yield (a-tax)
|
Cost of Equity
|
|
20%
|
80%
|
6.00%
|
8.50%
|
|
40%
|
60%
|
7.00%
|
9.00%
|
|
50%
|
50%
|
7.50%
|
11.00%
|
|
60%
|
40%
|
8.50%
|
12.00%
|
|
80%
|
20%
|
10.00%
|
14.00%
|
The CFO mentions to you that a debt ratio above 65% could cause more frequent reviews by the credit ratings agencies. The company does not issue preferred stock, and it intends to implement a payout ratio of 0% for at least the next three years. She is asking you to complete the following table so that she can evaluate all options:
|
Debt Ratio
|
Equity Ratio
|
WACC
|
|
20%
|
80%
|
|
|
25%
|
75%
|
|
|
30%
|
70%
|
|
|
35%
|
65%
|
|
|
40%
|
60%
|
|
|
45%
|
55%
|
|
|
50%
|
50%
|
|
|
55%
|
45%
|
|
|
60%
|
40%
|
|
|
65%
|
35%
|
|
|
70%
|
30%
|
|
|
75%
|
25%
|
|
|
80%
|
20%
|
|
What capital structure would you recommend (hint: determine the optimal capital structure)? Why?