2. In November 2010, Hertz Pain Relievers bought a massage machine that provided a re
2. In November 2010, Hertz Pain Relievers bought a massage machine that provided a return of 8%. It was financed by debt costing 7%. In March 2011, Mr. Hertz came up with a heating compound that would have a return of 14%. The Chief Financial Officer, Mr. Smith, told him it was impractical because it would require the issuance of common stock at a cost of 16% to finance the purchase. Is the company following a logical approach to using cost of capital? Explain your answer.
How to solve this problem?
3. St. Louie Department Store wants to put up a new store to add to its growing branches of stores. The question it is facing is to buy or lease a building. Land, building, furniture and equipment will cost a total of $850,000 with useful life of 18 years. Payment will compose of down payment of $350,000, and the balance of $500,000, which will be paid in equal yearly installment of $175,000 for the next four years. Annual payment for property taxes of P7,500, insurance of $8,000 and repair and maintenance cost of $4,500 will have to be incurred. The land can be sold at the end of 18 years for $500,000. For a long term lease contract of a building, an annual lease payment of $120,000 with $8,000 security deposit can be negotiated. The lessor will take care of the property taxes and insurance while St. Louie will shoulder the annual repair and maintenance. St. Louie's required rate of return is 16%. Annual net cash inflow of the new hospital is estimated to be well above the average compared with its other hospital branches. The Medical Director recommended that it is better to buy than to lease because although it will require more cash outlay at the beginning, the land can be sold for $500,000 at the end. Using the net present value approach, compute and determine whether St. Louie should lease or buy the new hospital
