Question
The Ali-baba Oil Company has ongoing two projects called Oil Rigs and SpecialDrills . Project Oil Rigs employs equal distribution of debt and equity. Equity
The Ali-baba Oil Company has ongoing two projects called"Oil Rigs"and"SpecialDrills". Project "Oil Rigs" employs equal distribution of debt and equity. Equity is also equallydistributed amongst preferred and common stock. Project "Specialty Drills" 30% debt, 50%common stock and remainder for preferred stock. The total capital employed for both projects aresame of $30000000.
For both projects at present, preferred stock can be sold yielding 17%. The current borrowing rateof both projects is 12 percent, and the company's tax rate is 40 percent. The company has thoughtabout using the capital-asset pricing model in this regard. It has identified two samples with modalvalue beta of0.8for Oil Rigs and Beta 2.2for Special Drills. The risk-free rate is currently 14percent and the expected return on the market portfolio 20 percent.
Required:
- a. Calculate required rate of return of equity of Oil Rigs and Special Drills. (2+2)
- b. Calculate Weighted Average Cost of Capital of Oil Rigs and Special Drills. (3+3)
- c. Calculate Economic Value Added if the net profit after taxes of Oil Rigs and Special Drillsfor both projects were $25000000. (2+2)
- d. Based on analysis in which project the Ali-baba Company should go for investment. (1)
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