Flax Industries is considering replacing a 4-year old FlaxXer Machine with a newer and more efficient FlaxXer Machine. You are to evaluate the problem based on the information below and make a decisions whether to replace the Old FlaXer Machine. You are also required to estimate a weighted average cost of capital (WACC) for the problem based on the information given. - Assume a combined Federal and State Tax Rate =20% for this problem - Round all dollar numbers to whole dollars. - Round all percentages to 2 decimals, e.g., 04563 becomes 4.56% NOT 4.6% Calculate WACC: Flax Industries finances its projects using a Target Capital Structure of: Cost of Short and Long Term Borrowing (3 points) 1. Flax Industries uses a permanent line of credit thru a Short-Term Credit Facility to finance Short-Term Notes at a flat rate cost of 5% yyear. (i.e., Rs-t =5% ) 2. Flax Industries can issue New Bonds with a $1000 par value bonds, a 4.50% coupon rate with a 30 -year maturity at a price of \$1041.95. Coupon payments are annually. Assume no flotation costs for issuing bonds. Find YTM=Rd Cost of Preferred Stock (3 points) 3. Flax can also issue New Preferred Stock paying a 7% dividend coupon on $25 par at a price =$24.56 per share. Flotation costs for issuing new Preferred Stock is equal to 5% of the sales price. Dividends are paid once per year. Estimate the cost of New Preferred Stock with flotation costs (Rp). Cost of Common Equity ( 9 points) 4. Flax's common stock is currently trading at $60 per share. Next year, Flax expects to pay a dividend of $.75/ share out of earnings of $3.75 per share (i.e, EPS1=$3.75;D1=$.75 ). Current Return on Equity = NOI/Equity =12% (i.e., ROE=12% ). Calculate the cost of equity (Rs) using the DDM: Rs=(D1/P0)+g. Remember an estimate of g=ROEb, where b is the percent of earnings retained within the firm: b= Earnings retained/EPS; Retained Earnings = EPS - dividends. 5. Analyst estimate the company's beta at =1.10; the 10 -year T-Note risk free rate =3%(Rf=3%); and the return on the market portfolio is estimated at 11.0%(Rm=11.0%). Using the CAPM estimate required return on equity (Rs). 6. Flax also estimates Cost of Equity using its 30-year Bond Yield +7% equity risk premium. What is the Cost of Equity? 7. Find an overall average Cost of Equity by averaging the costs you found in 4,5,&6 above. You will use this Rs estimate in calculating Flax Industries WACC in (8) below. 8. Calculate the WACC using the Target Structure weights given above, and your calculations for Short-Term Notes (1): Long Term Bonds YTM (2); Cost of Preferred Stock (3), and Overall Average for the Cost of Common Equity (7). You will use your WACC estimate in the Capital Budgeting Problem. (5 points) Calculation of the WACC for Capital Budget Problem Q1. Cost of Short-term debt is gliven at Q2. Cost of L-T Debt Bonds Coupon Rate = Maturity Fond Price Coupon PMT Bond VTM Q3. Cost of Preferred Stock Dividend Coupon Rate. Par Value Sales Price Flotation Costs Rp=Dividend/(Price(1F))= RP Q3 Q4. Cost of Common Equity using DDM =D1/P0+g DDM Q4 Q5. Cost of Common Equity using CAPM =Rf+(RmR) Beta CAPM Pf Rim Beta Q5 Q6. Cost of Common Equity for: Rs =YTM+ Equity Risk Premium YTM+prem YTM Equity Risk Q6 Q7. Find the Average of Rs in Q4, Q5, 8Q6=(Q4+Q+Q6)/3 Rs Q7 Q8. Find the WACC using the above values and weights below WACC = ? WACC Q8
