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Optimal Financing Mix

This document contains information about two investment projects. Project 1 does not provide any details. Project 2 provides financial information and calculates that the net present value is $33,333,333 and the internal rate of return is 100% based on a debt to equity ratio of 67%. An alternative calculation considers the total investment and cash flows to the firm, resulting in a net present value of $40,109,890. The document also provides financial information for a company including its balance sheet, bond and stock details. Several calculations are shown including the company's debt to equity ratios in book and market value terms, its after-tax cost of debt and cost of equity, and weighted average cost of capital.

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Sana Sarfaraz
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82 views4 pages

Optimal Financing Mix

This document contains information about two investment projects. Project 1 does not provide any details. Project 2 provides financial information and calculates that the net present value is $33,333,333 and the internal rate of return is 100% based on a debt to equity ratio of 67%. An alternative calculation considers the total investment and cash flows to the firm, resulting in a net present value of $40,109,890. The document also provides financial information for a company including its balance sheet, bond and stock details. Several calculations are shown including the company's debt to equity ratios in book and market value terms, its after-tax cost of debt and cost of equity, and weighted average cost of capital.

Uploaded by

Sana Sarfaraz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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Problem #1

Problem # 2
Initial investment 100,000,000
EBIT 20,000,000
Interest (4,000,000)
EBT 16,000,000
Taxes (6,400,000)
Net income 9,600,000

Depreciation expense 5,000,000

Debt / Equity ratio = 67%


Equity investment = 66,666,667
Cash flow to equity =
Net income 9,600,000
add: Depreciation 5,000,000
Net cash flow 14,600,000
PV of cash flow 100,000,000
NPV 33,333,333

b.
Total investment 100,000,000
Cash flow to firm = EBIT (1-t)+Depreciation
EBIT (1-t)= 12,000,000
Depreciation = 5,000,000
CF to firm = 17,000,000

PV of cash flow = 140,109,890


less: Investment (100,000,000)
NPV 40,109,890
Balance sheet
Assets Liabilities
Fixed assets $ 4,000 Debt $ 2,500
Current assets $ 1,000 Equity $ 2,500
Total $ 5,000 $ 5,000

The debt is in the form of long term bonds, with a coupon rate of
10%. The bonds are currently rated AA and are selling at a yield of
12%. (The market value of bond is 80% of the face value)
The firm currently has 50 million shares outstanding, and the current
market price is $80 per share. The firm pays a dividend of $4 per
share and has a price/earnings ratio of 10.

The stock currently has a beta of 1.2. The treasury bond rate is 8%.
The tax rate of the firms is 40%.
a. What is the debt to equity ratio for this firm in book value terms? In market
value terms?

Debt 2500 Debt/Equity ratio = 100%


Equity 2500
5000

Debt 2000 Debt/Equity ratio = 50%


50 Equity 4000
6000

b. What is the debt/(debt + equity) ratio of this firm in the book value terms?
In market value terms?

Debt 2500 Debt/(Debt + Equity) ratio = 50%


Equity 2500
5000

Debt 2000 Debt/(Debt + Equity) ratio = 33%


50 Equity 4000
6000
P/E = Price per share/EPS 4.2
10 = 80/EPS 80
EPS= 8 0.0525 0.1025
Payout ratio = 0.5
Growth rate = RoE(1-payout ratio) = 0.1*0.5
0.05
alue terms? In market c. What is the firm's after tax cost of debt?

After tax cost of debt = Kd(1-t)


After tax cost of debt = 0.12 (1-0.4) 7.20%

d. What is the firm's cost of equity?


risk free rate 8%
Risk premium 5.50%
Beta 1.2
Cost of equity 14.60%

he book value terms? e. What is the firm's current cost of capital?


Debt 2000 33% 7.20% 2.40%
Equity 4000 67% 14.60% 9.73%
6000 12.13%

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