I know they worked it out but im lost! can you please showme step by step and where the got the numbers
not on excel please
Name: Section: Q5. Project Cost of Capital (25 points) SAIPA Corp. is a publicly traded company that specializes in car manufacturing. The company's debt-to-equity ratio is 1/4 and it plans to maintain the same debt-to-equity ratio indefinitely. SAIPA's cost of debt is 7%, and its equity beta is 1.5. Risk free rate is 5%, market risk premium is also 5%, and corporate tax rate is 40%. a. Suppose that SAIPA is contemplating whether to start a new car production line. This project will be financed with 20% debt and 80% equity. The cost of debt for the new project is the same as current SAIPA's cost of debts. What discount rate should SAIPA use to discount the cash flows from its new car production project? (7 points) Answer: Notice that the new project and the firm share the same risk profile as they are both in car manufacturing business. The new project has also the same capital structure as the entire firm. Thus, we can directly use firm-wide WACC to discount cash flows of this project First, we apply CAPM to get equity cost of capital: re=r;+B!(E(Tmkt) - rp) = 5% +1.5.5% = 12.5% (2 points) I'wace rs+ pro(1 - 1) = 12.5% +*7% + (1 - 0.4) = 10.84% (5 points) Thus, the discount rate of the new project is 10.84%. Name: Section: b. Suppose SAIPA is considering the possibility of getting into speed boat manufacturing business. It plans to finance this new project equally with debt and equity. The cost of debt for the new project is 6%. SAIPA's CFO asked his associates to provide him with some financial information. Here is some of the information he has received Yamaha Boat Speed boat manufacturing Ford Motors Car manufacturing 0.75 Honda Marine Speed boat manufacturing 1.25 Industry D/E ratio Equity Beta Cost of Debt 1.4 1.8 5% 7% 6% Using the appropriate information from the table above, find what discount rate SAIPA should use to discount the cash flows from its speed boat manufacturing project. (Hint: you can calculate beta of debt from cost of debt using CAPM) (18 points) Answer: Notice that the project is in a different industry (boat manufacturing) from the firm (ear manufacturing). Therefore, we should use industry beta approach to compute the new project's cost of capital. First, we un-lever cost of capital of the comparable firms: Yamaha Boat and Honda Marine. Notice that Ford Motors is NOT one of the comparable firms here, as they do not operate in boat manufacturing industry. For Yamaha Boat, we have: BYamaha = BYamaha + byamaha Here, the D/E ratio for Yamaha is 1, the equity beta for Yamaha is 1.8. According to CAPM, debt beta for Yamaha is: (1 point if they directly used 0 as debt beta, give them the grade, because they realized beta of a risk-free asset is 0)) capital. First, we un-lever cost of capital of the comparable firms: Yamaha Boat and Honda Marine. Notice that Ford Motors is NOT one of the comparable firms here, as they do not operate in boat manufacturing industry. For Yamaha Boat, we have: Byamaha = D/EbYamaha + b BYamaha Here, the D/E ratio for Yamaha is 1, the equity beta for Yamaha is 1.8. According to CAPM. debt beta for Yamaha is: (1 point if they directly used 0 as debt beta, give them the grade, because they realized beta of a risk-free asset is 0)) rYamaha = r; +Byamaha (Ermkt) - rp) 5% = 5% + Byamaha - 5% Byamaha - 0 Thus, we have: Bxamaha - . Bxamaha + ubye Byamaha 0+ 1.8 = 0.9 (3 points) Name: Section: Similarly, for Honda, we have Blonda D/E 1+D/Blonda + 1 + De Bonda Here, the D/E ratio for Honda is 1.25, the equity beta for Honda is 2. According to CAPM, debt beta for Honda is: (1 points here they should show calculation of debt beta) Honda = r; + Honda (E(rm) - ro) 6% = 5% + Blonda .5% BHonda = 0.2 Thus, we have: BHonda = b Honda + Blonda = 12 + 2 = 1 (3 points) Therefore, the industry beta of the luxury department store industry is: (1 point) bind = 0.5BXamaha + 0.5B Honda = 0.95 Next, we need to re-lever beta: Here, D/E = 1, Bind = 0.95. According to CAPM: (1 point) P = r;+ Bb(E(rmki) - ro) 6% = 5% + B5.5% Bb = 0.2 Thus, B4 - (1 + (1+1). 0.95 - 1.0.2 = 1.7 (3 points) Here, the D/E ratio for Honda is 1.25, the equity beta for Honda is 2. According to CAPM, debt beta for Honda is: (1 points here they should show calculation of debt beta) Honda = r; + Blonda (E(r.mkt) -r) 6% = 5% + Honda 5% Honda = 0.2 Thus, we have: BHonda = D/E CHO = 1+1 Blonda + 1 enda = 125 0.2 + 12+ 2 = 1 (3 points) 1+1.25 Therefore, the industry beta of the luxury department store industry is: (1 point) Bind = 0.5BXmaha + 0.5Rende = 0.95 Next, we need to re-lever beta: B = (1 + 2 ) Bra - 2 Here, D/E-1, bind = 0.95. According to CAPM: (1 point) fp = r, +B5(E(Tmkt) - r.) 6% = 5% +B6 - 5% Bb = 0.2 Thus, Bi = (1+2) Bind-B6 = (1 +1) - 0.95 -1.0.2 = 1.7 (3 points) Next, we apply CAPM with the new equity beta: (2 points) ferr,+B!(Ermkt)-ri) = 5% +1.7.5% = 13.5% Finally, the project WACC with the target leverage is: (3 points) Name: Section: Here, D/ = 1, 7E = 13.5%, 7) = 6%, te=40%. Thus: D/E TwaceD/+ "E+ D/E + 1" 13.5% + 56%. (1 - 40%) = 8.55% 1+ 1 + 1 Therefore, the discount rate of the new project is 8.55%. Name: Section: Q5. Project Cost of Capital (25 points) SAIPA Corp. is a publicly traded company that specializes in car manufacturing. The company's debt-to-equity ratio is 1/4 and it plans to maintain the same debt-to-equity ratio indefinitely. SAIPA's cost of debt is 7%, and its equity beta is 1.5. Risk free rate is 5%, market risk premium is also 5%, and corporate tax rate is 40%. a. Suppose that SAIPA is contemplating whether to start a new car production line. This project will be financed with 20% debt and 80% equity. The cost of debt for the new project is the same as current SAIPA's cost of debts. What discount rate should SAIPA use to discount the cash flows from its new car production project? (7 points) Answer: Notice that the new project and the firm share the same risk profile as they are both in car manufacturing business. The new project has also the same capital structure as the entire firm. Thus, we can directly use firm-wide WACC to discount cash flows of this project First, we apply CAPM to get equity cost of capital: re=r;+B!(E(Tmkt) - rp) = 5% +1.5.5% = 12.5% (2 points) I'wace rs+ pro(1 - 1) = 12.5% +*7% + (1 - 0.4) = 10.84% (5 points) Thus, the discount rate of the new project is 10.84%. Name: Section: b. Suppose SAIPA is considering the possibility of getting into speed boat manufacturing business. It plans to finance this new project equally with debt and equity. The cost of debt for the new project is 6%. SAIPA's CFO asked his associates to provide him with some financial information. Here is some of the information he has received Yamaha Boat Speed boat manufacturing Ford Motors Car manufacturing 0.75 Honda Marine Speed boat manufacturing 1.25 Industry D/E ratio Equity Beta Cost of Debt 1.4 1.8 5% 7% 6% Using the appropriate information from the table above, find what discount rate SAIPA should use to discount the cash flows from its speed boat manufacturing project. (Hint: you can calculate beta of debt from cost of debt using CAPM) (18 points) Answer: Notice that the project is in a different industry (boat manufacturing) from the firm (ear manufacturing). Therefore, we should use industry beta approach to compute the new project's cost of capital. First, we un-lever cost of capital of the comparable firms: Yamaha Boat and Honda Marine. Notice that Ford Motors is NOT one of the comparable firms here, as they do not operate in boat manufacturing industry. For Yamaha Boat, we have: BYamaha = BYamaha + byamaha Here, the D/E ratio for Yamaha is 1, the equity beta for Yamaha is 1.8. According to CAPM, debt beta for Yamaha is: (1 point if they directly used 0 as debt beta, give them the grade, because they realized beta of a risk-free asset is 0)) capital. First, we un-lever cost of capital of the comparable firms: Yamaha Boat and Honda Marine. Notice that Ford Motors is NOT one of the comparable firms here, as they do not operate in boat manufacturing industry. For Yamaha Boat, we have: Byamaha = D/EbYamaha + b BYamaha Here, the D/E ratio for Yamaha is 1, the equity beta for Yamaha is 1.8. According to CAPM. debt beta for Yamaha is: (1 point if they directly used 0 as debt beta, give them the grade, because they realized beta of a risk-free asset is 0)) rYamaha = r; +Byamaha (Ermkt) - rp) 5% = 5% + Byamaha - 5% Byamaha - 0 Thus, we have: Bxamaha - . Bxamaha + ubye Byamaha 0+ 1.8 = 0.9 (3 points) Name: Section: Similarly, for Honda, we have Blonda D/E 1+D/Blonda + 1 + De Bonda Here, the D/E ratio for Honda is 1.25, the equity beta for Honda is 2. According to CAPM, debt beta for Honda is: (1 points here they should show calculation of debt beta) Honda = r; + Honda (E(rm) - ro) 6% = 5% + Blonda .5% BHonda = 0.2 Thus, we have: BHonda = b Honda + Blonda = 12 + 2 = 1 (3 points) Therefore, the industry beta of the luxury department store industry is: (1 point) bind = 0.5BXamaha + 0.5B Honda = 0.95 Next, we need to re-lever beta: Here, D/E = 1, Bind = 0.95. According to CAPM: (1 point) P = r;+ Bb(E(rmki) - ro) 6% = 5% + B5.5% Bb = 0.2 Thus, B4 - (1 + (1+1). 0.95 - 1.0.2 = 1.7 (3 points) Here, the D/E ratio for Honda is 1.25, the equity beta for Honda is 2. According to CAPM, debt beta for Honda is: (1 points here they should show calculation of debt beta) Honda = r; + Blonda (E(r.mkt) -r) 6% = 5% + Honda 5% Honda = 0.2 Thus, we have: BHonda = D/E CHO = 1+1 Blonda + 1 enda = 125 0.2 + 12+ 2 = 1 (3 points) 1+1.25 Therefore, the industry beta of the luxury department store industry is: (1 point) Bind = 0.5BXmaha + 0.5Rende = 0.95 Next, we need to re-lever beta: B = (1 + 2 ) Bra - 2 Here, D/E-1, bind = 0.95. According to CAPM: (1 point) fp = r, +B5(E(Tmkt) - r.) 6% = 5% +B6 - 5% Bb = 0.2 Thus, Bi = (1+2) Bind-B6 = (1 +1) - 0.95 -1.0.2 = 1.7 (3 points) Next, we apply CAPM with the new equity beta: (2 points) ferr,+B!(Ermkt)-ri) = 5% +1.7.5% = 13.5% Finally, the project WACC with the target leverage is: (3 points) Name: Section: Here, D/ = 1, 7E = 13.5%, 7) = 6%, te=40%. Thus: D/E TwaceD/+ "E+ D/E + 1" 13.5% + 56%. (1 - 40%) = 8.55% 1+ 1 + 1 Therefore, the discount rate of the new project is 8.55%
