Part 1 Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%.
Component Scenario 1 Scenario 2 Cost of Capital Tax Rate
Debt $4,000,000.00 $1,000,000.00 8% 30%
Preferred Stock 1,200,000.00 1,500,000.00 10%
Common Stock 1,000,000.00 3,700,000.00 13%
Total $6,200,000.00 $6,200,000.00
1A. Complete the table below to determine the WACC for each of the two capital structure scenarios.
Scenario 1 Scenario 2 Scenario 1 Scenario 2 Cost Tax
Weight % Weight % Weighted Weighted of Rate
Cost % Cost % Capital
Debt 64.52% 16.13% 3.61% 0.90% 8% 30%
Preferred Stock 19.35% 24.19% 1.94% 2.42% 10%
Common Stock 16.13% 59.68% 2.10% 7.76% 13%
Total 100.00% 100.00% 7.65% 11.08%
1B. Which capital structure shall Mr. Johnson choose to fund the new project?
A. Scenario 1
B. Scenario 2
Part 2
Assume the new project's operating cash flows for the upcoming 5 years are as follows:
Project A
Initial Outlay $ -6,200,000.00
Inflow year 1 1,270,000.00
Inflow year 2 1,750,000.00
Inflow year 3 1,750,000.00
Inflow year 4 2,160,000.00
Inflow year 5 2,450,000.00
WACC
2A. What are the WACC (restated from Part 1), NPV, IRR, and payback years of this project? ( WACC (from Part 1) 7.65%
NPV
IRR
Payback Method
2B. Shall the company accept or reject this project based on the outcome using the net present value (NPV) method?
A. Project A should be accepted.
B. Project A should be rejected