Preston Cove Biotechnology Limited was established in the year 2010 is expanding the business by considering investing in some profitable projects. You are the Finance Assistant manager of this firm and was asked to estimate the cost of capital and evaluate the following projects:

Table 1: Projected Cash Flows ($ in millions)

Year 0 1 2 3 4

Project X (100.00) 10.00 50.00 40.00 20.00

Project Y (200.00) 80.00 90.00 85.00 10.00

Project Z (300.00) 105.00 90.00 110.00 20.00

Albert, the Chief Financial Officer (CFO) of Preston Cove has provided you some relevant information.

1.The current bond price of Preston Cove's is 10% coupon, semiannual payment with 10 years left to maturity is $1,134.20. The par value of the bond is $1,000. The company's tax rate is 40%.

2.The current price of the preferred stock is $31.25 with annual dividend payment of $3.75.

3.Preston Cove's common stock is currently selling for $45 per share. Its last dividend payment was $3.25 and dividend is expected to grow at a constant rate of 3% in the foreseeable future. Preston Cove's beta is 1.2, the risk free rate is 6%, and the market risk premium is estimated to be 4%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4% with the yield on the Treasury bond of 6.5%.

Sharron, a finance manager of Preston Cove shared the following information: The firm has $400 million capital available consisting of $160 million debt, $140 preferred stock, and $100 million common stock.

Albert has asked to make a report answering the following questions:

a.What are the sources of capital to be included when estimating Preston Cove's WACC? In calculating the WACC, if he had to use book values for either debt or equity, which would he choose? Why?(7 marks)

b.What is the cost of debt after tax?(6 marks)

c.What is the firm's cost of preferred stock?(3 marks)

d.Explain why there is a cost of retained earnings?(3 marks)

e.What is Preston's Cove's estimated cost of common equity using the CAPM approach?(5 marks)

f.What is the estimated cost of common equity using the DCF approach?(5 marks)

g.What is the bond-yield-plus-risk-premium estimate for Preston Cove's cost of common equity?(3 marks)

h.What is your final estimate for r_sor the average required rate of return?(5 marks)

i.Explain in words why new common stock has a higher cost than retained earnings.(2 marks)

j.Preston Cove estimates that if it issues new common stock, the flotation cost will be 20%.Preston Cove incorporates the flotation costs into the DCF approach.What is the estimated cost of newly issued common stock, considering the flotation cost?(5 marks)

k.What is Preston Cove's overall, or weighted average, cost of capital (WACC)?Ignore flotation costs.(8 marks)

l.What are the factors affecting Preston Cove's composite WACC?(4 marks)

m.Calculate the Net Present Value (NPV), Discounted Payback Period (DPP) and Modified Internal Rate of Return (MIRR) for Project X, Y and Z.(36 marks)

n.Preston Cove has $400 million capital available. Since the projects above are independent, which project should the company invest?(2 marks)

o.If Preston Cove had 14% cost of equity, 6% preferred shares and 8% debt, Sharron proposed a target capital structure of 60% equity, 5% preferred shares, and 35% debt. Explain why she doesn't use more preferred shares since it costs less than debt.(6 marks)