Question
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
Assets | |
Current assets | $ 29,000,000 |
Net plant, property, and equipment | 105,000,000 |
Total assets | $134,000,000 |
Liabilities and Equity | |
Accounts payable | $ 8,000,000 |
Accruals | 6,000,000 |
Current liabilities | $ 14,000,000 |
Long-term debt (36,000 bonds, $1,000 par value) | 36,000,000 |
Total liabilities | $ 50,000,000 |
Common stock (5,000,000 shares) | 40,000,000 |
Retained earnings | 44,000,000 |
Total shareholders' equity | 84,000,000 |
Total liabilities and shareholders' equity | $134,000,000 |
The stock is currently selling for $17.224 per share, and its noncallable $1,000 par value, 10-year, 10% bonds with semiannual payments are selling for $1,080.00.
The beta is 1.30 while the real risk-free rate is(R*) is 2%. Inflation rates will be 3% during the first two years and 5% on the years thereafter. Treasury bonds are expected to have .10(T-1)% of maturity risk premium(MRP). The required return on the stock market is 10.50%, but the market has had an average annual return of 13.50% during the past 5 years. The firm's tax rate is 30%.
CGT is expected to issue P1.25 worth of dividend per share at the end of the year with a constant growth of 5% each year.
a What is the Treasury Bill and Treasury Bond rate?
b What is the YTM and the after-tax cost of debt?
c Using CAPM, what is the required rate of return of CGT stocks? (Remember for rRf , use the T-Bond rate computed in 25-26)
d Using DCF approach, what is the expected rate of return of CGT stocks if the retained earnings is sufficient to support the capital budget requirement?
e Using DCF approach, what is the expected rate of return of CGT stocks if the retained earnings is insufficient to support the capital budget requirement and the flotation rate is at 12%?
f Using Bond-Yield-Plus-Risk-Premium Approach with the 3% risk premium, what is the estimated cost of equity?
g What is the WACC assuming you have equal confidence with all the cost of equity approaches and the retained earnings is sufficient to support the capital budget requirement?
h Assuming the company would like to change its capital structure to 40% debt and 60% equity, what will be new levered beta? (Remember to compute first the unlevered beta)
i Using the new levered beta, what is the new WACC?
j Should the company change its capital structure? Why or why not?
k Assuming the company would like to invest in a machinery which will cost P880,000 and will provide an inflow of P200,000 for each of its6 year life, what is the companys payback and
l Using the information above, what is the projects NPV and Profitability index (using the new WACC computed in nos. 37-38)? Should it be accepted or not?
m What is the projects IRR?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started