PLEASE DETAIL THE ANSWERS

Assume that BF, Inc., has 10,000 bonds outstanding, paying a 5.6 percent coupon rate semi- annually and with a par value of $1,000 per bond. They all mature in 25 years and currently sell for 97 percent of par. Their current yield to maturity is 6.4%. The firms marginal tax rate is 35%.

The company also has 435,000 shares outstanding, currently selling for $61 per share. The stock beta of the company is currently estimated at 1.02. The current expected return to the market is 12 percent, and the current risk-free rate is 5.75 percent.

The firm is broken into three divisions: Textiles, Accessories, and Miscellaneous. The average Textiles project has a beta of 0.7; the average Accessories project has a beta of 1.3; and the average Miscellaneous project has a beta of 1.1.

The firm is currently considering the projects shown in the table below. The current approach isto use the firms WACC to evaluate all projects, but management sees the wisdom in adopting asubjective divisional cost of capital approach. Firm management is thus considering a divisionalcost of capital scheme in which they will use the firms WACC for Miscellaneous projects, the firms WACC minus 1 percent for Textiles projects, and the firms WACC plus 3 percent forAccessories projects.

Projects	Division	Expected return of each project	Beta of each project
A	Accessories	17%	1.3
B	Accessories	15%	1.2
C	Miscellaneous	13%	1.3
D	Miscellaneous	11%	0.7
E	Textiles	9%	0.8
F	Textiles	7%	0.5

Business Finance I

1) Compute the current weighted average cost of capital of the firm (WACC).

2) Which projects would be accepted/rejected if the company uses its cost of capital (WACC) as the hurdle rate? (hurdle rate means minimum required rate of return for accepting a project).

3) Which projects would be accepted/rejected if the company uses the subjective approach? (In this approach, as you can read in the text, the company adjusts its cost of capital to get specific hurdle rates for each division).

4) Would switching to an objective divisional cost of capital approach, where the WACC foreach division is based on that divisions average beta, improve they are accept/reject criteria any further? What would be the projects to accept under this objective approach?

5) Calculate the required rate of return on equity for each project using the specific beta of each project. Compute the specific WACC to each project and deduce the projects that actually should be accepted/rejected?

Note: When computing the WACC of a new project or of a specific division, you only have to compute the new cost of equity (using the new beta). All the rest (weight of equity, weight of debt, cost of debt, tax rate) remain unchanged in the WACC formula.