1. Changing WACC and optimal choice. Austin Enterprises is currently an all-equity firm. The firm is considering selling debt (bonds) and retiring some of the equity. However, at each level of debt, debt becomes moreexpensive (cost of debt is rising), and the riskiness of the equity also rises with more and more debt. Using a spreadsheet, determine the best combination of debt and equity for Austin Enterprises if

• The current beta of Austin Enterprises is 0.85.
• The current market return is 12%.
• The current risk-free rate is 3%.
• The total equity is 20,000,000 shares at $25 per share.
• Debt is sold in units of $2,000,000.
• The first unit of debt has a cost of 7.5%.
• The tax rate of Austin Enterprises is 40%.
• Foreachadditionalunitofdebt(eachadditional$2,000,000),thecostofdebtrisesby0.85%,andthebetaofAustinEnterprisesrisesby0.025.

2.Working capital impact on project. iCovers, Incorporated wants to make covers for all the products that Apple manufactures. The company is looking at new covers for the iPhone, iPad, iPalm, iThumb, and iEye. The initial investment in capital equipment will be $10,000,000. The projected revenues and costs are:

1 2 3 4 5 6

Revenue	$10,000,000	$13,000,000	$17,000,000	$23,000,000	$18,000,000	$12,000,000
Variable	$ 4,000,000	$ 5,200,000	$ 6,800,000	$ 9,200,000	$ 7,200,000	$ 4,800,000
Fixed	$ 1,500,000	$ 1,500,000	$ 1,500,000	$ 1,500,000	$ 1,500,000	$ 1,500,000
S, G & A	$ 1,250,000	$ 1,400,000	$ 1,750,000	$ 2,000,000	$ 2,000,000	$ 1,500,000

The initial investment in working capital is $2,000,000. However, working capital will increase or decrease each year so that it is always 20% of the anticipated revenue for the coming year. The equipment will be depreciated using a MACRS five-year life, and there is no salvage value for the equipment at the end of the six-year project. The tax rate for iCovers is 37%.

Using a spreadsheet, set up the projects incremental cash flows showing the initial outlay (both capital and working capital), the operating cashflow each year, and the change in working capital each year. Note that the company will terminate the project in year six. Then calculate the projects IRR and NPV if the projects discount rate is 14%.