Question 5 (20 marks)

Felix Corp has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The WACC is to be measure by using the following weight: 45% long-term debt and 55% common stock equity. The firms tax rate is 40%.

Debt: The firm can sell for $1,000, 10-year, $1,000-par-value bond paying annual interest at 9% coupon rate.

Common stock: The firms common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year is $4. The expected dividend growth rate is 6%.

1. Compute the after-tax cost of debt.
2. Compute the cost of common stock.
3. Compute the WACC for Felix Corp.
4. Felix Corp is now considering an investment project with internal rate of return of 45%. However, the nature of this investment project is significantly different from the companys original operation therefore the top management of the Felix Corp has difficulty in evaluating the appropriate discount rate for this project. If you were the external financial advisor to the Felix Corp, what will be your advice?