Question 1

a) IIC Plantation faces increasing needs for capital. Fortunately it has an AA credit rating, which allowing the company an easy access to the capital. The firm's financial manager is trying to determine the firm's current (2019) weighted average cost of capital in order to assess the profitability of capital budgeting projects.

The company's common stock has a price of $98.44 and a current dividend of $3.15 per share. The par value of the common stock is $88. The historical growth pattern for dividends is as follows:

Last year $2.81

Last 2 years $2.51

Last 3 years $2.24

Last 4 years $2.00

Last 5 years $1.93

The firm can sell the preference capital at its $10 per share par value. The dividend for the preference share is 19% of the par value. The cost of issuing and selling the preference capital is expected to be 5% of the market price.

The table below shows the different bond issues of comparative market prices of equal risk to IIC Plantation:

Data on Bond Issues

Issues S&P's Rating Price

Costcom 8, 2023 AAA $975.25

DBE 7, 2028 AA $850.75

Gurney Holdings 9.62, 2025 A $960.50

The corporate tax rate is 40 percent.

IIC Plantation has the following target capital structure proportions, to calculate its weighted average cost of capital:

Long-term debt $691,200

Common Equity $1,728,000

Preferred Stock $460,800

Calculate the weighted average cost of capital for IIC Plantation using the market value weights, based on the information given. (17 marks)

b) IIC Plantation is deciding between two mutually exclusive projects. The two projects have the following cash flows:

Project A Project B

Year Cash Flow Cash Flow

0 ($50,000) ($30,000)

1 $10,000 $6,000

2 $15,000 $12,000

3 $40,000 $18,000

4 $20,000 $12,000

Using the weighted average cost of capital (WACC) calculated in a), calculate the net present value (NPV) and the internal rate of return (IRR) of the project. Which project should you choose? (8 marks)