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1) Penny Blossoms has a target capital structure of 40% debt and 60% equity
1) Penny Blossoms has a target capital structure of 40% debt and 60% equity. Its cost of equity is 1%, cost of debt is 5%, and its tax rate is 25%. What is Penny Blossom's WACC? 2) What would happen to the WACC if it changed its capital structure to 50%/50% (no math just theory, explain your answer)?
This is problem 15 on pages 268-269 in the textbook. Use the table below to calculate the payback following. Your required return is 13% and your company mandates only projects with a 3-year payback period or less be considered.
3) Calculate the Payback period for both of these projects. Assume the projects are mutually exclusive, which project, if any would you accept? Briefly explain your answer.
4) Calculate the Profitability Index for both of these projects. Assume the projects are mutually exclusive, which project, if any, would you accept? Briefly explain your answer.
5) Calculate IRR for both of these projects. IRR doesn't work with mutually exclusive projects so treat them as independent. Which project, if any, would you accept? Briefly explain your answer.
6) Calculate the NPV for both of these projects. Assume the projects are mutually exclusive. Which project, if any, would you choose? Briefly explain your answer.
7) Based on all of the information, which project would you choose. Briefly explain your answer.
Year // Project A // Project B
0 -$245,000 -$53,000
1 $34,000.00 $31,900.00
2 $49,000.00 $21,800.00
3 $51,000.00 $17,300.00
4 $325,000.00 $16,200.00
Expert Solution
1) WACC = 2.10%
2) WACC = 2.38%
If the cost of debt and cost of equity will change to 50%/50% then the weighted average cost of capital increase by 2.38%.
3) Payback period for project A = 3.34 years
Payback period for project B = 1.97 years
If the projects are mutually exclusive the project that have lower payback period than required payback period (3 years) should be accepted. So, the project B should be accepted because it has lower payback period.
4) Profitability index for project A = 1.53
Profitability index for project B = 1.45
If the projects are mutually exclusive the project that have higher probability index should be accepted. So, the project A should be accepted because it has higher probability index.
5) IRR for project A = 20.54%
IRR for project B = 27.38%
If the projects are independent the project that have IRR greater than the required return should be accepted. So, the project A and project B should be accepted.
6) NPV for project A = $130,936.32
NPV for project B = $23,853.59
If the projects are mutually exclusive the project that have higher NPV should be accepted. So, the project A should be accepted because it has higher NPV.
7) Based on the above information we should choose the project A because it has higher NPV. We should choose the project on the basis of NPV because it depends on time value of money.
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