Question: Part 1 A: Bremond Equipment Supply Corporation (BESC) needs to determine its Weighted Average Cost of Capital in order to make a few capital budgeting decisions. The firm has already established the proporation of its capital. Use these proportions in calculating the firm's WAAC.
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Target Market
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Source of Capital
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Proportions
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Long-term debt
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69%
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Preferred stock
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5%
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Common stock equity
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26%
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Debt: BESC can sell a 15-year, semi-annual,$1,000 par value, 8.75 percent bond for $985. A flotation cost of 1.75 percent of the face value would be required in addition to the discount of $15.
Preferred Stock: BESC has determined it can issue preferred stock at $70 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $2 per share.
Common Stock: BESC's common stock is currently selling for $42 per share. The dividend expected to be paid at the end of the coming year is $5.35 Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.00. It is expected that to sell, a new common stock issue must be underpriced at $4 per share and the firm must pay $1 per share in flotation costs.
Additionally, the firm's marginal tax rate is 40 percent.
To help determine the firm's WACC, we will break this problem down into steps:
Calculate the rate for the new bond issue, notice is has semi-annual compounding.
Calculate the after-tax cost of the bond issue.
Calculate the cost of the new issue of preferred stock.
Calculate the growth rate of the common stock dividends.
Calculate the cost of the new common stock issue.
Finally, calculate the firm's weighted average cost of capital assuming the firm has exhausted all retained earnings.
Part 1 B: Bremond Equipment Supply Corporation is now considering investment in two independent projects, A and C, which are described below. Please don't assume anything. Use the firm's WACC which you just calculated to evaluate the projects.
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Option A
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Option C
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Initial Investment
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$3,250,000
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$3,900,000
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Year
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Cash Inflows (CF)
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1
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$1,500,000
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$1,800,000
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2
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1,000,000
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1,000,000
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3
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1,000,000
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900,000
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4
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1,500,000
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1,500,000
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Do not cut and paste this chart into your excel spreadsheet. Something in the formatting causes excel to calculate it incorrectly!
Calculate Payback Period for both projects
Calculate NPV for both projects
Calculate PI for both projects
Calculate IRR for both projects
Which project should the firm accept? Why?