Question 1 20 marks You have determined in your mind that you would like to have a business of your own, although your father runs a family restaurant in your local city. You have therefore, decided to have a medium size snack and cocktails bar which will accommodate the cruise ship passengers who visit your city. You plan to keep the business for five years after which you will sell it off to your brother John for $2,000,000 and go off to do your Masters Degree in the UK. Though you will be occupying the establishment from your grandmother for free, you have decided that you need to make some improvements to the property which will cost you $1,500,000. Additionally, you will spend $275,000 in bar stools, tables and decorations. If this space had been leased out, it would have fetched a lease rental of $75,000 per year. You will depreciate the assets over 7 years using MACRS. You have determined that you would need an average cash balance of $15,000 and inventory of $20,000 while Accounts payable should average $10,000. You plan to borrow the money from a local bank and pay interest at a rate of 15 percent. To increase your chances of success at the business you plan to have your cousin Johnathan to conduct a market survey which will cost you $100,000. Your new venture will decrease the revenue your family business will earn by $15,000 per year and you have agreed to allow your father to take this amount from your allowance as a shareholder of the family restaurant.

Revenues are projected to be $500,000 the first year and is expected to increase by 20% the second year, 15% the third year and to continue to increase at 10% thereafter. Fixed annual operating costs are expected to be salaries of $110,000, Utilities $75,000, Food and Liquor License is 15% of gross revenues and taxes are 40% of net revenues.

Required: A. Calculate the initial outlay and depreciable value of the project. (2 marks) B. Calculate the annual after-tax operating cash flow for Years 1 -5. (6 marks) C. Determine the terminal year (in year 5) after-tax non-operating cash flow. (4 marks) D. What is the project NPV? (4 marks) E. What is the estimated Internal Rate of Return (IRR) of the project? Should the project be accepted based on the IRR criterion? Why? (4 marks)

2.

Additional Information: i. The Long-Term debt consists of 8% annual coupon bonds, with 15 years to maturity and are currently selling for 95% of par. ii. The companys common shares which have a book value of $20 per share are currently selling at $25 per share.

iii. Preferred shares have a book value of $100 per share. These shares are currently selling at $120 per share and pays dividends of 6% per annum on book value. iv. The dividend growth rate is expected to be 3%, and dividend for 2023 is projected to be $5.00 per share. v. The Companys Tax rate is 30%.

Required: Determine the following for Tram-Ropes Limited: A. Total Market value of the firms capital structure (3 marks) B. After-tax Cost of Debt (2 marks) C. Cost of Common Stock (2 marks) D. Cost of Preferred Stock (1 mark) E. WACC (2 marks)

Question 3 2 marks Why is the cost of financing a project with retained earnings less than the cost of financing it with a new issue of common stock?

Question 4 3 marks The cost of preferred stock is 6 percent, and the cost of debt is 8 percent. The relevant tax rate is 35 percent. The company president has approached you about its capital structure. He wants to know why the company doesnt use more preferred stock financing because it costs less than debt. What would you tell the president?

Reference is made to the 2022 Balance Sheet of Tram-Ropes limited