marinerl
Aug 17, 2010, 05:03 AM
Hi, I'm new to the forum and I love for some help on my homework assignment. I've tried doing the first part of it but I'm not sure if I did it correctly, so I'll post my calculations and I was hoping someone could check my work and correct me if I'm wrong. I also have a few questions about some of the informaion provided in the assignment.
I have a homework assignment in which I have to choose 1 of 3 capital budgeting projects listed. Table 1 shows the expected after tax operating cash flows for each project and all other information necessary for the calculations. The projects have a 4 year life span. They have the same size, but differen cash flow patterns. THey also differ in business risk as indicated by their unlevered betas.
Not only do I have to recommend 1 of the 3 capital budgeting projects, I have to evaluate 3 capital structures for financing the project: no debt, 20% debt, and 50% debt. If debt is used, the cost of the debt will depend upon the amount of leverage in the capital structure. Table 1 shows the before-tax cost of debt at 20% and 50% leverage.
The cost of capital is 15% based on a dividend plus growth model, but the projects risk leves are different from the company and from each other. Also the projects have no long term growth so instead the CAPM model will be used to estimate the cost of equity.
Table 1: Operating Cash Flows after Tax
A
0 (20,000,000)
1 7,000,000
2 7,000,000
3 7,000,000
4 7,000,000
Risk Free Rate: 2%
Return on Market: 14%
Cost of Debt 20% Leverage: 7%
Cost of Debt 50% leverage: 16%
Tax Rate: 30%
Beta: 0.9
Here are the answers I got for 0% leverage:
Beta: 0.9
(B_L = B_U [1 + (1-T) D/E])
= 0.9(1 + (1 - 0.3) 0/1.0)
Cost of Equity: 12.8%
(2 + 0.9(14-2)) Am I right to believe Cost of Equity is also CAPM?
WACC: 12.8%
D/A(r_d)(1-T) + (E/A)(r_s)
0(15)(1-0.3)+(1)(12.8) I'm not sure if I did this part correctly
NPV: 908120.18
I did this one on my calculator using the NPV function
IRR: 14.96
MIRR: 1.11632
I also did this one on my calculator, though I'm not sure if this is the right answer
Aside from being unsure of my answers, I don't understand what the professor meant with providing 20% leverage cost of debt: 7%. I thought that a 20% leverage cost of debt is that you have 20% debt and 80% equity. Can someone correct me please? I know this is a lot of information, but any help would be appreciated, thank you so much.
I have a homework assignment in which I have to choose 1 of 3 capital budgeting projects listed. Table 1 shows the expected after tax operating cash flows for each project and all other information necessary for the calculations. The projects have a 4 year life span. They have the same size, but differen cash flow patterns. THey also differ in business risk as indicated by their unlevered betas.
Not only do I have to recommend 1 of the 3 capital budgeting projects, I have to evaluate 3 capital structures for financing the project: no debt, 20% debt, and 50% debt. If debt is used, the cost of the debt will depend upon the amount of leverage in the capital structure. Table 1 shows the before-tax cost of debt at 20% and 50% leverage.
The cost of capital is 15% based on a dividend plus growth model, but the projects risk leves are different from the company and from each other. Also the projects have no long term growth so instead the CAPM model will be used to estimate the cost of equity.
Table 1: Operating Cash Flows after Tax
A
0 (20,000,000)
1 7,000,000
2 7,000,000
3 7,000,000
4 7,000,000
Risk Free Rate: 2%
Return on Market: 14%
Cost of Debt 20% Leverage: 7%
Cost of Debt 50% leverage: 16%
Tax Rate: 30%
Beta: 0.9
Here are the answers I got for 0% leverage:
Beta: 0.9
(B_L = B_U [1 + (1-T) D/E])
= 0.9(1 + (1 - 0.3) 0/1.0)
Cost of Equity: 12.8%
(2 + 0.9(14-2)) Am I right to believe Cost of Equity is also CAPM?
WACC: 12.8%
D/A(r_d)(1-T) + (E/A)(r_s)
0(15)(1-0.3)+(1)(12.8) I'm not sure if I did this part correctly
NPV: 908120.18
I did this one on my calculator using the NPV function
IRR: 14.96
MIRR: 1.11632
I also did this one on my calculator, though I'm not sure if this is the right answer
Aside from being unsure of my answers, I don't understand what the professor meant with providing 20% leverage cost of debt: 7%. I thought that a 20% leverage cost of debt is that you have 20% debt and 80% equity. Can someone correct me please? I know this is a lot of information, but any help would be appreciated, thank you so much.