Why Choose Us?
0% AI Guarantee
Human-written only.
24/7 Support
Anytime, anywhere.
Plagiarism Free
100% Original.
Expert Tutors
Masters & PhDs.
100% Confidential
Your privacy matters.
On-Time Delivery
Never miss a deadline.
The Soy Company has ongoing two projects called “Project 1” and “Project 2”
The Soy Company has ongoing two projects called “Project 1” and “Project 2”. Project 1 employs 40% debt, 30% common stock and remainder for preferred stock. Project 2 employs equal distribution of debt and equity. Equity is also equally distributed amongst preferred and common stock. The total capital employed for both projects are same of 40 million. For both projects at present, preferred stock can be sold yielding 15%. The current borrowing rate of both projects is 13 percent, and the company's tax rate is 40 percent. The company has thought about using the capital-asset pricing model in this regard. It has identified two samples with modal value betas of 1.8 for Project 1 and 0.6 for project 2. The risk-free rate is currently 10 percent and the expected return on the market portfolio 17 percent. Required: a. Calculate required rate of return of equity of Project 1 and Project 2. (2+2) b. Calculate Weighted Average Cost of Capital of Project 1 and Project 2. (3+3) Calculate Economic Value Added if the net profit after taxes of Project 1 were 15 million and for Project 2 were 18 million.
Expert Solution
Calculation of Required rate of return of equity
Ke = Rf + beta*(E(rm) - Rf)
Ke = Cost of equity
Rf = risk free rate
E(rm) = Expected return of market
Using formula given above:
Project 1 (ke) = 10% + 1.80*(17% - 10%) = 22.60%
Project 2 (ke) = 10% +0.60*(17% - 10%) = 14.20%
(b). Calculation of WACC Project 1
Cost of equity P1 = 22.60%
Cost of equity P2 = 14.20%
Cost of debt for for both projects = 13%
after tax cost of debt = 13%(1 - 0.40) = 7.80%
Cost of preffered stock = 15%
Project 1 weights :
Debts. = 0.40
Common stock = 0.30
Preffered stock = 0.30
WACC = (ke*we) + (kd*wd) + (kp*wp)
WACC = (22.60%*0.30)+(7.80%*0.40)+(15%*0.30)
WACC = 6.78%+3.12%+4.50% = 14.40%
WACC for project 2:
WACC = (14.20%*0.25)+(7.80*0.50)+(15%*0.25)
WACC = 3.55%+3.90%+3.75%= 11.20%
Calculation Of EVA would be as follows
EVA = NOPAT - (WACC*Capital investment)
NOPAT = EBIT (1 - tax)
Calculation of EBIT For project 1
EBT = 15millions/0.60 = 25 millions
EBIT = EBT + interest
EBIT = 25 +40*0.40*13% = 27.08 millions
NOPAT = 27.08(1 - 0.40) = 16.248 millions
EVA = 16.248 - ( 40*14.40% )= 10.488 millions
Calculation of EVA for project 2
EBT = 18/0.60 = 30 millions
EBIT = 30 + 40*0.50*13% = 32.60 millions
NOPAT = 32.60(1 - 0.40) = 19.56 millions
EVA = 19.56 - (40*11.20%) = 15.08 millions
Archived Solution
You have full access to this solution. To save a copy with all formatting and attachments, use the button below.
For ready-to-submit work, please order a fresh solution below.
