Finance 306Show your work

These problems should be evaluated given the Payback criteriaand the NPVrates. Cost of Capital, specifically: Cost of Long Term Debt, Cost of Preferred Stock, Cost of Common Stock (new issue), and Weighted Average Cost of Capital.

Review Cash Flow Material

Problem 1

Company XYZ is considering an investment opportunity in '11. The financials associated with this project for year 1 are:

Sales350,000

Expenses (Ex Dep) 265,000

Sales & Expenses are expected to increase by 1% per year - after year 1

Fixed Asset (Investment) associated with this project are expected to cost 150,000

Fixed Assets will be depreciated via the 5 year MACRS. The project will be evaluated over 3 years.

Problem 2

They intend to finance the project similar to the way they have historically financed projects.

Pertinent data is as follows:

Existing Capital Structure

Bonds 50,000

Preferred Stock 150,000

Common Stock 300,000

Bond Market rate '107.0%

Bond Market rate '11 (projected) 9.0%

Company believes they could issue Preferred Stock at a price of $31.00

The dividend associated with this would be $2.50

Flotation costs would be 3% of the sales price

Problem 3

Company also believes they could issue Common Stock at a price of $39.00

Flotation costs would be 2% of the sales price

Dividend will be based on historic growth.

Dividend History is as follows:

Dividend History

Year Dividend

2008 2.00

2009 2.07

2010 2.16

Company is in the 40% tax bracket

The company evaluates all projects using both Payback & NPV. Their internal criteria relating to Payback allows for a maximum of 3 years.

The hurdle rate to be used with NPV is Cost of Capitalplus 5%.

Given the above - should they proceed under both methods.

BONUS - What is the maximum hurdle rate that is acceptable - show/prove your answer.