This assignment will allow you to demonstrate the following objectives:
- Compute the net present value, profitability index, and internal rate of return for a given company.
- Predict the best choice for a company based on analysis of financial data.
- Compute a company’s WACC using given percentages.
- Calculate the cost of capital of a stock.
- Computer the after-tax cost of capital for bonds.
Instructions: Answer the questions directly on this document. When you are finished, select “Save As,” and save the document using this format: Student ID_UnitVIII. Upload this document to BlackBoard as a .doc, docx, or .rtf file. Show all of your work.
- The Turnip Company plans to issue preferred stock. Currently, the company’s stock sells for $110. Once new stock is issued, the Turnip Company would receive only $90. The dividend rate is 8%, and the par value of the stock is $100. Compute the cost of capital of the stock to your firm. Show all work.
- The Maximus Corporation is considering a new investment, which would be financed from debt. Maximus could sell new $1,000 par value bonds at a new price of $920. The bonds would mature in 13 years, and the coupon interest rate is 10%. Compute the after-tax cost of capital to Maximus for bonds, assuming a 34% tax rate. Show work.
- Connor Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 10%.
| Project 1 | Project 2 | |
| Initial investment | $(465,000) | $(700,000) |
| Cash inflow Year 1 | $510,000 | $850,000 |
Compute the following for each project:
- NPV (net present value)
- PI (profitability index)
- IRR (internal rate of return)
Based on your analysis, answer the following questions :
- Which is the best choice? Why?
- Which project should be selected and why? If the projects had the same IRR amounts but different NPV totals, then how would you know which project to select? Explain.
- What would happen if both projects had negative NPV totals? Which project would you choose? What do negative NPVs indicate? Explain.
- Should we also use the payback method to assist us in project selection? Why or why not? Explain.
- The capital structure for Magellan Corporation is shown below. Currently, flotation costs are 13% of market value for a new bond issue and $3 per share for preferred stock. The dividends for common stock were $2.50 last year and have an estimated annual growth rate of 6%. Market prices are $1,020 for bonds, $20 for preferred stock, and $30 for common stock. Assume a 34% tax rate.
| Financing Type | % of Future Financing |
| Bonds (8%, $1k par, 16 year maturity) | 36% |
| Common equity | 45% |
| Preferred stock (5k shares outstanding, $50 par, $1.50 dividend) | 19% |
| Total % | 100% |
Compute the company’s WACC. Is this WACC considered reasonable given the assumptions and other relevant information? Explain.
Question III