I am stuck on Question 7. I am not sure how to compute Net Present value of each of the projects. This is all of the information provided for me and my own work up to question 7.

Sophia was recently hired by Great Wall Co. as a junior budget analyst. She is working for the Venture Capital Division and has been given for capital budgeting projects to evaluate. She must give her analysis and recommendation to the capital budgeting committee.

The Capital Budgeting Projects

She must choose one of the four capital budgeting projects listed below:

Table 1

t	A	B	C	D
0	(16,000,000)	(20,000,000)	(19,000,000)	(18,000,000)
1	5,500,000	7,000,000	8,200,000	9,000,000
2	5,500,000	8,000,000	8,200,000	7,000,000
3	7,000,000	8,000,000	5,200,000	6,000,000
4	7,000,000	1,000,000	5,200,000	5,000,000
Risk	Low	Average	High	Average

Table 1 shows the expected after-tax operating cash flows for each project. All projects are expected to have a 4 year life. The projects differ in size (the cost of the initial investment), and their cash flow patterns are different. They also differ in risk as indicated in the above table.

The capital budget is $20 million and the projects are mutually exclusive.

Capital Structures

Great Wall Co. has the following capital structure, which is considered to be optimal:

Debt	40%
Preferred Equity	10%
Common Equity	50%
	100%

Cost of Capital

Sophia knows that in order to evaluate the projects she will have to determine the cost of capital for each of them. She has been given the following data, which he believes will be relevant to her task.

(1)The firms tax rate is 30%.

(2) Great Wall Co. has issued a 13% semiannual coupon bond with 10 years term to maturity. The current trading price is $1,206.

(3) The firm has issued some preferred stock which pays an annual 9% dividend of $100 par value, and the current market price is $110.

(4) The firms stock is currently selling for $68 per share. Its last dividend (D₀) was $4, and dividends are expected to grow at a constant rate of 8%. The current risk-free return offered by Treasury security is 2.5%, and the market portfolios return is 10.5%. Great Wall Co. has a beta of 1.5.

(5) The firm adjusts its project WACC for risk by adding 2.5% to the overall WACC for high-risk projects and subtracting 2.5% for low-risk projects.

Analysis

1. What is the firms cost of debt?

Given: Great Wall Co. has issued a 13% semiannual coupon bond with 10 years term to maturity. The current trading price is $1,206

Estimated cost of debt by computing YTM on existing debt.

N= 10 years x 2(semiannual compounding)=20;PMT= .13x$1000= 13/2=$65; PV= -$1,206; FV=$1000; CPT I/Y=4.87% x 2 = 9.74% = R_D

2. What is the cost of preferred stock for Great Wall Co.?

Given: The firm has issued some preferred stock which pays an annual 9% dividend of $100 par value, and the current market price is $110.

RP = D / P₀

P0=110 D= .09x100= 9

9/110=.08x100 = 8.18% = R_PS

3. Cost of common equity

(1) What is the estimated cost of common equity using the CAPM approach?

Given: The firms stock is currently selling for $68 per share. Its last dividend (D₀) was $4, and dividends are expected to grow at a constant rate of 8%. The current risk-free return offered by Treasury security is 2.5%, and the market portfolios return is 10.5%. Great Wall Co. has a beta of 1.5.

R_E = R_f +_E x (R_M R_f); Risk-free rate= R_f Market risk premium= (R_M) R_f Systematic risk of stock=

2.5%+1.5 x (10.5%-2.5%)= 14.5%

(2) What is the estimated cost of common equity using the DCF approach?

R_E = D₁/P₀ + g D₁= D₀ x (1+g) g=8%, P₀=$68, D₀=$4

4 x (1+.08)= 4.32

(4.32 / 68) +.08= 14.35%

(3) What is the final estimate for cost of equity?

(14.5 + 14.35) / 2 = 14.43% = R_E

4. What is Great Wall Co.s overall WACC?

Given: Weighted of debt= W_D=.40; Weighted of Preferred equity=W_PS=.10; Weighted of equity=W_E=.50

WACC = W_E x R_E + W_D x R_D +W_PS x R_PS x (1-T_C)

(.5 x .1443) + .4 x (.0974) + (.1 x .0818) x (1-.30)

WACC=11.68%

5. Do you think the firm should use the single overall WACC as the hurdle rate for each of its projects? Explain.

No, the firm should not use the overall WACC. The WACC has not been adjusted for the varying degrees of riskiness of each project.

6. What is the WACC for each project? Place your numerical solutions in Table 2.

High-risk WACC= 2.5%+11.68%= 14.18% Avg-Risk=11.68% Low-Risk = 11.68% - 2.5% = 9.18 %

7. Calculate all relevant capital budgeting measures for each project, and place your numerical solutions in Table 2. I Used IRR formula in Excel to calculate percentages from cash flows.

Table 2

	A	B	C	D
WACC	9.18%	11.68%	14.18%	11.68%
NPV
IRR	19%	9%	17%	21%

Risk Low Avg High Avg

8. Comment on the commonly used capital budgeting measures. What is the underlying cause of ranking conflicts? Which criterion is the best one, and why?

9. Which of the projects are unacceptable and why?

10. Rank the projects that are acceptable, according to Sophias criterion of choice.