CASE II

You work for HydroTech, a large manufacturer of high-pressure industrial water pumps. The firm specializes in natural disaster services, ranging from pumps that draw water from lakes, ponds, and streams in drought-strickers areas to pumps that remove high water volumes in flooded areas. You report directly to CFO. Your boss has asked you to calculate HydroTech's WACC in preparation for an executive retreat. Too bad you 're not invited as water pumps and skiing are on the agenda in Sun Valley, Idaho. At least you have an analyst on hand to gather the following required information:

1. The risk-free rate of interest, in this case, the yeild of the ten-year government bond, which is 3%.

2. HydroTech's:

a. Market capitalization (its market value of equity), $100 million.

b. CAPM beta, 1.2.

c. Total book value of debt outstanding, $50 million.

d. Cash, $10 million.

3. The cost of debt (using the quoted yields on HydroTech's outstanding bond issues), which is 5%.

With this information on hand, you are now prepared to undertake the analysis.

Please answer the following questions based on the case above:

Q.1. Calculate HydroTechs net debt. Q.2. Compute HydroTechs equity and (net) debt weights based on the market value of equity and the book value of net debt. Q.3. . Calculate the cost of equity capital using the CAPM, assuming a market risk premium of 5%. Q.4. Using a tax rate of 35%, calculate HydroTechs effective cost of debt capital. Q.5. Calculate HydroTechs WACC. Q.6. When is it appropriate to use this WACC to evaluate a new project?