A thumbs up will be given: Table 1 t A B C D 0 (14,900,000) (17,900,000) (16,600,000) (19,700,000) 1 4,980,000 5,990,000 3,850,000 6,400,000 2 4,980,000 ...

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Finance

A thumbs up will be given:
Table 1
t
A
B
C
D
0
      (14,900,000)
      (17,900,000)
      (16,600,000)
       (19,700,000)
1
         4,980,000
         5,990,000
         3,850,000
         6,400,000
2
         4,980,000
         6,210,000
         4,990,000
         5,880,000
3
         4,510,000
         6,250,000
         6,860,000
         6,800,000
4
         4,510,000
         4,700,000
         4,990,000
         6,650,000
Risk
High
Average
Low
Average
Table 1 shows the expected after-tax operating cash flows foreach project. All projects are expected to have a 4 year life. Theprojects differ in size (the cost of the initial investment), andtheir cash flow patterns are different. They also differ in risk asindicated in the above table.
The capital budget is $20 million and the projects are mutuallyexclusive.
Capital Structures
Imagine Software Inc. has the following capital structure, whichis considered to be optimal:
Debt
35%
Preferred Equity
15%
Common Equity
50%
100%

Cost of Capital
Max knows that in order to evaluate the projects he will have todetermine the cost of capital for each of them. He has been giventhe following data, which he believes will be relevant to histask.
(1)The firm’s tax rate is 40%.
(2) Imagine Software Inc. has issued a 9% semi-annual couponbond with 7 years term to maturity. The current trading price is$988.
(3) The firm has issued some preferred stock which pays anannual 8.5% dividend of $100 par value, and the current marketprice is $94.
(4) The firm’s stock is currently selling for $76.5 per share.Its last dividend (D₀) was $2.80, and dividends areexpected to grow at a constant rate of 7.5%. The current risk freereturn offered by Treasury security is 3.1%, and the marketportfolio’s return is 10%. Imagine Software Inc. has a beta of1.25. For the bond-yield-plus-risk-premium approach, the firm usesa risk premium of 2.8%.
(5) The firm adjusts its project WACC for risk by adding 2% tothe overall WACC for high-risk projects and subtracting 2% forlow-risk projects.
Max knows that Imagine Software Inc. executives have favored IRRin the past for making their capital budgeting decisions. Hisprofessor at Seattle U. said NPV was better than IRR. His textbooksays that MIRR is also better than IRR. He is the new kid on theblock and must be prepared to defend his recommendations.
First, however, Max must finish the analysis and write hisreport. To help begin, he has formulated the followingquestions:
What is the firm’s cost of debt?
What is the cost of preferred stock for Imagine SoftwareInc.?
Cost of common equity
(1) What is the estimated cost of common equity using the CAPMapproach?
(2) What is the estimated cost of common equity using the DCFapproach?
(3) What is the estimated cost of common equity using thebond-yield-plus-risk-premium approach?
(4) What is the final estimate for r_s?
What is Imagine Software Inc.’s overall WACC?
Do you think the firm should use the single overall WACC as thehurdle rate for each of its projects? Explain.
What is the WACC for each project? Place your numericalsolutions in Table 2.
Calculate all relevant capital budgeting measures for eachproject, and place your numerical solutions in Table2.
Table 2
A
B
C
D
WACC
NPV
IRR
MIRR
Comment on the commonly used capital budgeting measures. Whatis the underlying cause of ranking conflicts? Which criterion isthe best one, and why?
Which of the projects are unacceptable and why?
Rank the projects that are acceptable, according to Max’scriterion of choice.
Which project should Max recommend and why? Explain why each ofthe projects not chosen was rejected.
Instructions:
Answer table 2 and questions 5-11
Questions 5, 8, 9, and 11 are discussion questions,Place your numerical solutions in Table 2, show all calculationsteps
Here are the answers from 1-4
What is the firm’s cost of debt?
Pre-tax cost=RATE(72,9%1000/2,-988,1000)2=9.24%
After-tax cost=RATE(72,9%1000/2,-988,1000)2(1-40%)=5.54%
What is the cost of preferred stock for Imagine SoftwareInc.?
=8.5%100/94=9.04%
Cost of common equity
(1) What is the estimated cost of common equity using the CAPMapproach?
=3.1%+1.25(10%-3.1%)=11.73%
(2) What is the estimated cost of common equity using the DCFapproach?
=2.80(1+7.5%)/76.5+7.5%=11.43%
(3) What is the estimated cost of common equity using thebond-yield-plus-risk-premium approach?
=RATE(72,9%1000/2,-988,1000)2+2.8%=12.04%
(4) What is the final estimate for rs?
=(11.73%+11.43%+12.04%)/3=11.73%
What is Imagine Software Inc.’s overall WACC?
=35%5.54%+15%9.04%+50%11.73%=9.16%

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A thumbs up will be given:Table 1tABCD0 (14,900,000) (17,900,000) (16,600,000) (19,700,000)1 4,980,000 5,990,000 3,850,000 6,400,0002 4,980,000 6,210,000 4,990,000 5,880,0003 4,510,000 6,250,000 6,860,000 6,800,0004 4,510,000 4,700,000 4,990,000 6,650,000RiskHighAverageLowAverageTable 1 shows the expected after-tax operating cash flows foreach project. All projects are expected to have a 4 year life. Theprojects differ in size (the cost of the initial investment), andtheir cash flow patterns are different. They also differ in risk asindicated in the above table.The capital budget is $20 million and the projects are mutuallyexclusive.Capital StructuresImagine Software Inc. has the following capital structure, whichis considered to be optimal:Debt 35%Preferred Equity15%Common Equity50%100% Cost of CapitalMax knows that in order to evaluate the projects he will have todetermine the cost of capital for each of them. He has been giventhe following data, which he believes will be relevant to histask.(1)The firm’s tax rate is 40%.(2) Imagine Software Inc. has issued a 9% semi-annual couponbond with 7 years term to maturity. The current trading price is$988.(3) The firm has issued some preferred stock which pays anannual 8.5% dividend of $100 par value, and the current marketprice is $94.(4) The firm’s stock is currently selling for $76.5 per share.Its last dividend (D0) was $2.80, and dividends areexpected to grow at a constant rate of 7.5%. The current risk freereturn offered by Treasury security is 3.1%, and the marketportfolio’s return is 10%. Imagine Software Inc. has a beta of1.25. For the bond-yield-plus-risk-premium approach, the firm usesa risk premium of 2.8%.(5) The firm adjusts its project WACC for risk by adding 2% tothe overall WACC for high-risk projects and subtracting 2% forlow-risk projects.Max knows that Imagine Software Inc. executives have favored IRRin the past for making their capital budgeting decisions. Hisprofessor at Seattle U. said NPV was better than IRR. His textbooksays that MIRR is also better than IRR. He is the new kid on theblock and must be prepared to defend his recommendations.First, however, Max must finish the analysis and write hisreport. To help begin, he has formulated the followingquestions:What is the firm’s cost of debt?What is the cost of preferred stock for Imagine SoftwareInc.?Cost of common equity(1) What is the estimated cost of common equity using the CAPMapproach?(2) What is the estimated cost of common equity using the DCFapproach?(3) What is the estimated cost of common equity using thebond-yield-plus-risk-premium approach?(4) What is the final estimate for rs?What is Imagine Software Inc.’s overall WACC?Do you think the firm should use the single overall WACC as thehurdle rate for each of its projects? Explain.What is the WACC for each project? Place your numericalsolutions in Table 2.Calculate all relevant capital budgeting measures for eachproject, and place your numerical solutions in Table2.Table 2ABCDWACCNPVIRRMIRRComment on the commonly used capital budgeting measures. Whatis the underlying cause of ranking conflicts? Which criterion isthe best one, and why?Which of the projects are unacceptable and why?Rank the projects that are acceptable, according to Max’scriterion of choice.Which project should Max recommend and why? Explain why each ofthe projects not chosen was rejected.Instructions:Answer table 2 and questions 5-11Questions 5, 8, 9, and 11 are discussion questions,Place your numerical solutions in Table 2, show all calculationstepsHere are the answers from 1-4What is the firm’s cost of debt?Pre-tax cost=RATE(7*2,9%*1000/2,-988,1000)*2=9.24%After-tax cost=RATE(7*2,9%*1000/2,-988,1000)*2*(1-40%)=5.54%What is the cost of preferred stock for Imagine SoftwareInc.?=8.5%*100/94=9.04%Cost of common equity(1) What is the estimated cost of common equity using the CAPMapproach?=3.1%+1.25*(10%-3.1%)=11.73%(2) What is the estimated cost of common equity using the DCFapproach?=2.80*(1+7.5%)/76.5+7.5%=11.43%(3) What is the estimated cost of common equity using thebond-yield-plus-risk-premium approach?=RATE(7*2,9%*1000/2,-988,1000)*2+2.8%=12.04%(4) What is the final estimate for rs?=(11.73%+11.43%+12.04%)/3=11.73%What is Imagine Software Inc.’s overall WACC?=35%*5.54%+15%*9.04%+50%*11.73%=9.16%

	A	B	C	D
WACC

NPV
IRR
MIRR

t	A	B	C	D
0	(14,900,000)	(17,900,000)	(16,600,000)	(19,700,000)
1	4,980,000	5,990,000	3,850,000	6,400,000
2	4,980,000	6,210,000	4,990,000	5,880,000
3	4,510,000	6,250,000	6,860,000	6,800,000
4	4,510,000	4,700,000	4,990,000	6,650,000
Risk	High	Average	Low	Average