Homework Set #4: Chapters 8 9, 10, & 11
Directions: Show your work in all mathematical calculation and explain your written responses. Submit your assignment using the assignment link on the course cell. Use this word document as your template. Start your answer at the end of each question.
1. Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt (bond) at par (1000) with a coupon rate of 8%, 15 years time to maturity and currently selling at 955 dollars. Bad boys also plan to issue a new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital?
25 points
Your Answer:
B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, given risk-free rate of 4% and market risk premium of 8% and a beta of 1.20 what is Bad Boys new cost of capital? Note the cost of debt and cost of a preferred stay at levels spelled out in part A above. (Use capital asset pricing model to find the cost of equity)
10 points
Your Answer:
2. Given the following: stock price 48.50, strike price 40.00, risk-free rate 4%, time to maturity of 6 months, stock’s volatility of 35% using Black-Sholes option pricing model, calculate the option premiums of:
A. Call option
20 points
Your Answer:
B. Is this call in or out of the money? Explain
4 points
Your Answer:
C. Put option
15 points
Your Answer:
D. Is this put in or out of the money: Explain?
4 points
Your Answer:
3. In your own words, identify two corporations that have dealt with cannibalization and what steps were taken to overcome the cannibalization. Please provide any citations and references. Please be articulate in your responses.
I. Define cannibalization and state why it should be accounted for in a project’s cash flow
(3 points)
Your Answer:
ii. State the first case of corporate cannibalization and the steps taken to overcome it
(3 points)
Your Answer:
iii. State the second case of corporate cannibalization and the steps taken to overcome it
(3 points)
Your Answer:
4. Company A wants to set up a new factory.
Building Cost = 30,000 (assume straight-line depreciation over 30 yrs with no salvage value)
Equipments and Installation cost = 15,000 (assume straight-line depreciation over 10 yr with no salvage value)
Initial Working Capital Investment = 10,000
At the end of the project’s economic life (5years)
The building is estimated to have a market value of 18,000 and a book value of 20,000
The equipment is expected to also have a market value of 7,500 and a book value of 5,000.
Given the estimated annual revenue of 50,000 and annual production cost of 25,000. Also, assume a marginal tax rate of 25%.
Find
A. Initial investment outlay:
3 points
Your Answer:
B. Project cash flow from operations:
5 points
Your Answer:
C. The cash flow at the end of the project
5 points
Your Answer:
Bonus Points
1. Your best friend invested in a project with an initial cash flow of 2400 dollars. The first-month business was booming, and he was able to bring in $ 2800, however, on second month the machine he invested in broke down costing him $ 800 in repairs. Knowing that you are in a finance class your friend called on your expertise in helping him to figure out what is the project’s internal rate of return at two months point. He wants you to numerically show that his project can result in two possible IRR. (Show your work, Excel will not work 100%)
10 points
Your Answer:
2. A. Consider Capital budgeting projects A and B which yield the following cash flows over their five-years live. The cost of capital for the project is 10%. Calculate the projects NPV.
| Project A | Project B | |
| Year | Cash Flow | Cash Flow |
| 0 | $-1000 | $-1000 |
| 1 | 500 | 100 |
| 2 | 400 | 200 |
| 3 | 200 | 200 |
| 4 | 200 | 400 |
| 5 | 100 | 700 |
A. Calculate the project’s NPV from each of the above projects.
3 points
Your Answer:
B. Which of these two projects should be undertaken if they are independent of each other?
1 point
Your Answer:
C. Which of these two projects should be undertaken if they are mutually exclusive projects?
1 point
Your Answer:
D. What is the payback period for each of these two projects?
2 points
6. Your best friend approaches you with a proposal to invest in a project with the flowing cash flow
Year cash flow
0 -800
1 5,000
2 -5,000
What is this project’s Modified internal rate of return? (WACC=10%)
3 points