The Capital Budgeting Projects He must choose one of the four capital budgeting projects listed below: Table 1 t B in D 0 (26,000,000) (23,500,000) (19.500,000) (19.920,000) 1 7,500,000 9.900.000 7.700,000 8,500,000 2 7.500.000 8,200,000 7.700,000 7,500,000 3 7,000,000 7.800.000 6,700,000 6,500,000 4 7,000,000 1.200,000 5,200,000 5,500,000 Risk Low Average Average High Table 1 shows the expected after tax operating cash flows for each project. All projects are expected to have a 4 year life. The projects differ in size (the cost of the initial investment), and their cash flow patterns are different. They also differ in risk as indicated in the above table. The capital budget is $20 million and the projects are mutually exclusive Capital Structures Blusea Petroleum has the following capital structure, which is considered to be optimal Debt 40% Preferred Equity 10% Common Equity 50 100% Cost of Capital Brandon knows that in order to evaluate the projects he will have to determine the cost of capital for each of them. He has been given the following data, which he believes will be relevant to his task. (1) The firm's tax rate is 35% (2) BluSea Petroleum has issued a 11% semi-annual coupon bond with 15 years term to maturity. The current trading price is $1180. (3) The firm has issued some preferred stock which pays an annual 9.5% dividend of 5100 par value, and the current market price is $115. (4) The firm's stock is currently selling for $128 per share. Its last dividend (Do) was $4.5, and dividends are expected to grow at a constant rate of 8.5%. The current risk free return offered by Treasury security is 3.5%, and the market portfolio's return is 10.25%. Blusea Petroleum has a bets of 1.35. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 3,8% (5) The firm adjusts its project WACC for risk by adding 25% to the overall WACC for high-risk projects and subtracting 2.6% for low-risk projects Brandon knows that BluSea Petroleum executives have favored IRR in the past for making their capital budgeting decisions His professor at Seattle U said NPV was better than IRR His textbook says that MIRR is also better than IRR. He is the new kid on the block and must be prepared to defend his recommendations Flest, however, Brandon must finish the analysis and write his report. To help begin he has formulated the following questions: 1. What is the firm's cost of debt? 2. What is the cost of preferred stock for Bluses Petroleum 3. Cost of common equity (1) What is the estimated cost of common equity using the CAPM approach? 1 What is the imms cost of debt 2. What is the cost of preferred stock for Blusea Petroleum? 3. Cost of common equity (1) What is the estimated cost of common equity using the CAPM approach? (2) What is the estimated cost of common equity using the DCF approach? (3) What is the estimated cost of common equity using the bond-vield-plus-risk-premium approach? (4) What is the final estimate for re? 4. What is BluSea Petroleum's overall WACC? 5. Do you think the firm should use the single overall WACC as the hurdle rate for each of its projects? Explain 6. What is the WACC for each project? Place your numerical solutions in Table 2 7. Calculate all relevant capital budgeting measures for each project and place your numerical solutions in Table 2 Table 2 B D WACC NPV IRR 6. What is the WACC for each project? Place your numerical solutions in Table 2. 7. Calculate all relevant capital budgeting measures for each project, and place your numerical solutions in Table 2 Table 2 A 100 B WACC NPV IRR MIRR 8. Comment on the commonly used capital budgeting measures. What is the underlying cause of ranking conflicts? Which criterion is the best one, and why? 9. Which of the projects are unacceptable and why? 10. Rank the projects that are acceptable, according to Brandon's criterion of choice 11. Which project should Brandon recommend and why? Explain why each of the projects not chosen was rejected. The Capital Budgeting Projects He must choose one of the four capital budgeting projects listed below: Table 1 t B in D 0 (26,000,000) (23,500,000) (19.500,000) (19.920,000) 1 7,500,000 9.900.000 7.700,000 8,500,000 2 7.500.000 8,200,000 7.700,000 7,500,000 3 7,000,000 7.800.000 6,700,000 6,500,000 4 7,000,000 1.200,000 5,200,000 5,500,000 Risk Low Average Average High Table 1 shows the expected after tax operating cash flows for each project. All projects are expected to have a 4 year life. The projects differ in size (the cost of the initial investment), and their cash flow patterns are different. They also differ in risk as indicated in the above table. The capital budget is $20 million and the projects are mutually exclusive Capital Structures Blusea Petroleum has the following capital structure, which is considered to be optimal Debt 40% Preferred Equity 10% Common Equity 50 100% Cost of Capital Brandon knows that in order to evaluate the projects he will have to determine the cost of capital for each of them. He has been given the following data, which he believes will be relevant to his task. (1) The firm's tax rate is 35% (2) BluSea Petroleum has issued a 11% semi-annual coupon bond with 15 years term to maturity. The current trading price is $1180. (3) The firm has issued some preferred stock which pays an annual 9.5% dividend of 5100 par value, and the current market price is $115. (4) The firm's stock is currently selling for $128 per share. Its last dividend (Do) was $4.5, and dividends are expected to grow at a constant rate of 8.5%. The current risk free return offered by Treasury security is 3.5%, and the market portfolio's return is 10.25%. Blusea Petroleum has a bets of 1.35. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 3,8% (5) The firm adjusts its project WACC for risk by adding 25% to the overall WACC for high-risk projects and subtracting 2.6% for low-risk projects Brandon knows that BluSea Petroleum executives have favored IRR in the past for making their capital budgeting decisions His professor at Seattle U said NPV was better than IRR His textbook says that MIRR is also better than IRR. He is the new kid on the block and must be prepared to defend his recommendations Flest, however, Brandon must finish the analysis and write his report. To help begin he has formulated the following questions: 1. What is the firm's cost of debt? 2. What is the cost of preferred stock for Bluses Petroleum 3. Cost of common equity (1) What is the estimated cost of common equity using the CAPM approach? 1 What is the imms cost of debt 2. What is the cost of preferred stock for Blusea Petroleum? 3. Cost of common equity (1) What is the estimated cost of common equity using the CAPM approach? (2) What is the estimated cost of common equity using the DCF approach? (3) What is the estimated cost of common equity using the bond-vield-plus-risk-premium approach? (4) What is the final estimate for re? 4. What is BluSea Petroleum's overall WACC? 5. Do you think the firm should use the single overall WACC as the hurdle rate for each of its projects? Explain 6. What is the WACC for each project? Place your numerical solutions in Table 2 7. Calculate all relevant capital budgeting measures for each project and place your numerical solutions in Table 2 Table 2 B D WACC NPV IRR 6. What is the WACC for each project? Place your numerical solutions in Table 2. 7. Calculate all relevant capital budgeting measures for each project, and place your numerical solutions in Table 2 Table 2 A 100 B WACC NPV IRR MIRR 8. Comment on the commonly used capital budgeting measures. What is the underlying cause of ranking conflicts? Which criterion is the best one, and why? 9. Which of the projects are unacceptable and why? 10. Rank the projects that are acceptable, according to Brandon's criterion of choice 11. Which project should Brandon recommend and why? Explain why each of the projects not chosen was rejected