Homework Set #4: Chapters 9, 10, & 11 (x2)
Worth 100 points

Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above. (Solve in Excel Worksheet).unv

A. Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue 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 a 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?

B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys cost of capital?

C. On page 457, your textbook details the term Cannibalization. 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.

Click here to view the grading rubric.

Points: 100	Homework Set 4: Chapters 9, 10, and 11
Criteria	Unacceptable Below 70% F	Fair 70-79% C	Proficient 80-89% B	Exemplary 90-100%A
1. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital? Weight: 30%	Did not submit or incompletely calculated Bad Boys, Inc.’s cost of capital.	Partially calculated Bad Boys, Inc.’s cost of capital.	Satisfactorily calculated Bad Boys, Inc.’s cost of capital.	Thoroughly calculated Bad Boys, Inc.’s cost of capital.
2. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys cost of capital? Weight: 30%	Did not submit or incompletely calculated Bad Boys, Inc.’s cost of capital.	Partially calculated Bad Boys, Inc.’s cost of capital.	Satisfactorily calculated Bad Boys, Inc.’s cost of capital.	Thoroughly calculated Bad Boys, Inc.’s cost of capital.
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. Weight: 30%	Did not submit or incompletely identified two corporations that have dealt with cannibalization and what steps were taken to overcome cannibalization. Did not submit or incompletely provided citations and references.	Partially identified two corporations that have dealt with cannibalization and what steps were taken to overcome cannibalization. Partially provided citations and references.	Satisfactorily identified two corporations that have dealt with cannibalization and what steps were taken to overcome cannibalization. Satisfactorily provided citations and references.	Thoroughly identified two corporations that have dealt with cannibalization and what steps were taken to overcome cannibalization. Thoroughly provided citations and references.
4. Clarity, writing mechanics, and formatting requirements. Weight: 10%	More than 6 errors present	5-6 errors present	3-4 errors present	0-2 errors present

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As a financial consultant, you have contracted with Wheel Industries to evaluate their procedures involving the evaluation of long term investment opportunities. You have agreed to provide a detailed report illustrating the use of several techniques for evaluating capital projects including the weighted average cost of capital to the firm, the anticipated cash flows for the projects, and the methods used for project selection. In addition, you have been asked to evaluate two projects, incorporating risk into the calculations.
You have also agreed to provide an 8-10 page report, in good form, with detailed explanation of your methodology, findings, and recommendations.
Company Information
Wheel Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35%.
Required:

Wheel has just paid a dividend of $2.50 per share. The dividends are expected to grow at a constant rate of six percent per year forever. If the stock is currently selling for $50 per share with a 10% flotation cost, what is the cost of new equity for the firm? What are the advantages and disadvantages of using this type of financing for the firm?
The firm is considering using debt in its capital structure. If the market rate of 5% is appropriate for debt of this kind, what is the after tax cost of debt for the company? What are the advantages and disadvantages of using this type of financing for the firm?
The firm has decided on a capital structure consisting of 30% debt and 70% new common stock. Calculate the WACC and explain how it is used in the capital budgeting process.
Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.
If the discount rate were 6 percent calculate the NPV of the project. Is this an economically acceptable project to undertake? Why or why not?
Now calculate the IRR for the project. Is this an acceptable project? Why or why not? Is there a conflict between your answer to part C? Explain why or why not?

Wheel has two other possible investment opportunities, which are mutually exclusive, and independent of Investment A above. Both investments will cost $120,000 and have a life of 6 years. The after tax cash flows are expected to be the same over the six year life for both projects, and the probabilities for each year’s after tax cash flow is given in the table below.

Investment B

Investment C

Probability

After Tax Cash Flow

Probability

After Tax Cash Flow

0.25

$20,000

0.30

$22,000

0.50

32,000

0.50

40,000

0.25

40,000

0.20

50,000

What is the expected value of each project’s annual after tax cash flow? Justify your answers and identify any conflicts between the IRR and the NPV and explain why these conflicts may occur.
Assuming that the appropriate discount rate for projects of this risk level is 8%, what is the risk-adjusted NPV for each project? Which project, if either, should be selected? Justify your conclusions.

 

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