1. Wheel Industries is considering a three year expansion project. The project requires an initial investment of $1.5 million.

The project will use straight line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million and has costs of $600,000. The tax rate is 35%. Calculate the cash flows for the project. If the discount rate is 6% calculate the NPV of the project. Depreciation = Cost of the asset salvage value Life of the asset = 1,500,000/ 3 = 500,000 Calculation of cash flows: Revenue 1,200,000 Less Cost 600,000 Less Depreciation 500,000 Profit 100,000 Less taxes (35%) 35,000 Profit after taxes 65,000 Add depreciation 500,000 Cash flow after taxes 565,000 NPV = Present value of cash flows - Cash outlay = 565,000 x PVIFA 6%, 3 years 1,200,000 = 565,000 x 2.6730 1,200,000 = 1,510,245 1,200,000 = 310,245 As the NPV is positive the project should be accepted. 2. Clinton Co. has just paid a dividend of $2.50 per share. The dividends are expected to grow at a constant rate of 6% per year for ever. If the stock is currently selling for $50 per share, calculate the cost of equity for the firm. Cost of equity Capital = D1 + g P0 D1 = D0 (1 + g) = 2.50 (1 + 0.06) = 2.65 Cost of equity capital = 2.65 + 0.06 50 = 0.113 or 11.3% 3. The Jersey Cos common stock has beta of 1.25. The risk free rate is 4% and the expected return on the market is 12%. What is the firms cost of equity? CAPM model: Cost of equity = Risk free rate + beta x (Market return Risk free rate) = 4% + 1.25 (12% - 4%) = 4% + 10% = 14%

4. The WW Inc. has 9% coupon bonds outstanding. They have a maturity of 13 Years and are selling for $1,080. The face value is $1,000 and the interest is paid semi-annually. Calculate the cost of debt on a pre-tax basis. What will be the after tax cost of debt if the tax rate is 35%? Cost of debt = Interest + (maturity value current price)/ years to maturity (Maturity value + current price)/2 = 90 + (1,000 1,080)/ 13 (1,000 + 1,080)/ 2 = 0.0806 or 8.06% After tax cost of debt = Cost of debt (1 tax rate) = 8.06% (1 35%) = 5.239% 5. BW Co. has a target debt equity ratio of 0.6. Its cost of debt is 12% and its cost of equity is 20%. If the corporate tax rate is 34%, what is the firms WACC? WACC = Wd x Kd (1 tax rate) + We x Ke Calculation of weights: Debt-equity ratio = Debt/ Equity = 0.6 Debt = 0.6 Equity Debt + Equity = 1 0.6 Equity + Equity = 1 1.6 Equity = 1 Equity or We = 1/1.6 Debt = 1 1/1.6 Debt or Wd = 0.6/ 1.6 WACC = 0.6/1.6 x 12%(1 0.34) + 1/1.6 x 20% = 2.97% + 12.5% = 15.47% 6. MW Co. has a target capital structure of 35% common equity, 10% preferred equity and 55% debt. The cost of common equity is 18%, the cost of preferred equity is 8% and the pre-tax cost of debt is 10%. If the corporate tax rate is 35%, what is MWs WACC? If the firm has a project with an IRR of 12% would you accept the project? WACC = Wd x Kd (1 tax rate) + Wp x Kp +We x Ke = 0.55 x 10% (1 0.35%) + 0.10 x 8% + 35% x 18% = 3.575% + 0.8% + 6.3% = 10.675% If the IRR is 12%, then the project should be accepted as Internal rate of return earned is greater than the cost of capital.