Q3 (20 Points)

CoCo Inc. is a conglomerate firm in the United States. Its business covers many sectors, such as real estate, finance, and hotels. To make sure optimal financial decisions are made, the CEO, Mr. Richard Cookson wants to better understand the companys cost of capital. Currently, CoCo Inc. has 10 million shares of common stocks outstanding, 100,000 grade A corporate bonds, as well as 250,000 grade B+ corporate bonds. The common stock has a book value of $10 per share and currently sells for $30 per share. The common stocks total risk is twice as much as the market portfolio and its systematic risk is 1.5 times the market portfolio. The grade A bond sells at 90% of its face value, with semi-annual coupon payment, 10% coupon rate, and 10 years to maturity. The grade B+ bond sells at 110% of its face value, with annual coupon payment, 20% coupon rate, and 10 years to maturity. The return of the risk-free asset is 4%. The return of the market portfolio is 12%. The tax rate is 40%. (The face value is $1,000 for each bond.)

a. (4 Points) What is the CoCo Inc.s cost of stock and cost of debt?

b. (6 Points) What is CoCo Inc.s WACC?

Mr. Cookson is evaluating the following two independent projects:

Project X is in the real estate industry and last for three years. It requires an initialinvestment of $1.5 million and will generate cash inflows of $0.5 million in each of the first two years, and $1 million in the last year. Meanwhile, another company that purely focuses on the very similar real estate business has a beta of 1. Project Y is in the finance industry. It requires an initial investment of $2 million and will generate a cash inflow of $0.2 million in each year forever. Another company that pure focuses on the very similar finance business has a beta of 0.5.

c. (4 Points) What are the IRRs for Projects X and Y?

d. (2 Points) Given the project information and the firms WACC, which project should the company accept and why? (Must provide explanation to get any point.)

e. (4 Points) What are the discounted payback periods for each of these two projects? What are their profitability indexes?