1. Golden Corporation is considering the purchase of new equipment costing $200,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $35,000 per year for the next 10 years. The probabilities for the increase in net income depend on the state of the economy.

After tax

After tax Probabilities Net Income

Recession 0.3 ($15,000)

Normal 0.5 25,000

Boom 0.2 35,000

The equipment can be amortized using straight-line amortization for tax purposes. Golden's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment?

1. Saven Travel Corporation is considering several investment opportunities in order to diversify its operations. Mr. Saven, president, is trying to determine the firm's cost of capital before he makes a decision. This diversification plan will require the firm to raise $400 million. A share of common stock is currently selling for $50, and the amount of the last dividend paid was $1.25. The company's earnings and dividends have been growing at about 12%, however, this is expected to drop to 9% per year in the future. Flotation costs of new common will be $4.00 per share. The firm can raise $150 million internally through retained earnings. The firm's investment dealer has informed Mr. Saven that this amount of equity can support $100 million in 12% coupon bonds. The company's tax rate is 46%.

A) Compute the weighted average cost of capital on the first $250 million of funds.

B) Saven Travel will need to raise $150 of additional capital for expansion. How much of this will be debt and equity?

C) Compute the marginal cost of capital on the additional $150 million assuming the cost of debt stays the same.