Question
ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100, 6% coupon
ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100, 6% coupon rate, and 10 years to maturity. The common stock has a standard deviation of return of 30% and a correlation coefficient with S&P 500 return of 0.75. The S&P500 has a return of 12.5% and a standard deviation of return of 20%. The T-bill rate is 3.5%. The debt has a default risk premium of 2% and a maturity risk premium of 1%. The stockholders are expected to receive a dividend of $2 five years hence and a stock price of $105 five years hence. ABC Inc. has a corporate tax rate of 30%.
1. If ABC has an investment that requires an outlay of $100 million, and generates cash flow of $60 million in one year, $40 million in two years and $15 million in three years. Use both net present value and internal rate of return criteria to determine if the investment is acceptable.
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