IFM11 Solution To Ch10 P18 Build A Model-2

 

2/1/2012

Chapter 10. Solution for Ch10 P18 Build a Model INPUTS USED IN TE M!DE"

+0

#$0.00

,et +pf  -pf 

#%0.00 #%.%0

-0 g ./T r d Skye's beta arket risk premium 2+ 

#2.10 &'

2isk free rate r 2F Target capital structure from debt Target capital structure from preferred stoc Target capital structure from common stoc Tax rate Flotation cost for common

(.$' )$' $' $0' %$' 10'

10' 0.8% (.0'

preferred -to,3 a. Cal,ulate the ,o-t of ea,h ,apital ,oponent that i- the afterta ,o-t of det the ,o-t of preferred 4in,ludin5 flotation ,o-t-6 and the ,o-t of e7uit 4i5norin5 flotation ,o-t-6. U-e oth the DC9 ethod and the C:PM ethod to find the ,o-t of e7uit. Cost of debt:

 

./T r d

3

 

10

(1 – T) !"

4/T rd

=

 

(.$0'

Cost of preferred stock (including flotation costs):

 

-pf

5

,et +pf  

#$%$0

=

r pf 

#$0%00

11.00'

Cost of common equity, DCF (ignoring flotation costs):

 

-1 #&%&"

5

+0 #"0%00

6

 

g 

=

r s 11.)*'

Cost of common equity, CAPM:

r 2F

6

!%"

 b 3 2+  %*

= +

r s 11.)8'

IMP!;T:NT N!TE< E;E TE C:PM :ND TE DC9 MET!DS P;!DUCE :PP;!=IM:TE"> TE S:ME

 

  C!ST !9 E?UIT>. E?UI T>. T:T !CCU;;ED BEC:USE @E US USED ED : BET: IN TE P;!B"E P;!B"EM M T:T 9!;CED TE S:ME ;ESU"T. ;ESU"T. !;DIN:;I"> !;DIN:;I"> TE T@! MET!DS @I"" P;!DUCE S!ME@:T S!ME@ :T DI99E;ENT ;ESU"TS. ;E SU"TS. . Cal,ulate the ,o-t of neA -to,3 u-in5 the DC9 odel.

 

-0 3 (1 6 g) #&%&"

5

+0 3 (1 – F)  6 #"%00

 

g 

=

r e 11.**'

,. @hat i- the ,o-t of neA ,oon -to,3 a-ed on the C:PMG 4int< 9ind the differen,e etAeen r e and r - adeterined  the DC9 ethod and add that differential to the C:PM alue for r -.6

r s 11%*

6 6

-ifferential 0%"0

= =

r e 11.*8'

:5ain Ae Aould not norall find that the C:PM and DC9 ethod- ield identi,al re-ult-. d. :--uin5 that that ao Aill not i--ue neA e7uit and Aill ,ontinue to u-e the -ae ,apital -tru,ture Ahat ithe ,opanH- @:CCG

:d

"%0

:pf  :s

"%0 "0%0 100%0

 

:d 3 4/T r d 6 &%$

:pf  3 r pf

6

0%""

:s 3 r s "%"

= =

7488 *.22'

e. Suppo-e ao i- ealuatin5 three proe,tproe,t- Aith the folloAin5 ,hara,teri-ti,-< ,hara,teri-ti,-<  

4166 Ea,h 41 Ea,h pr pro oe, e,tt ha ha- a ,o ,o-t -t of #1 i ill llio ion. n. Th The e Ai Aill ll al alll e fi fina nan, n,ed ed uu-in in5 5 th the e ta tar5 r5et et i i  of lo lon5 n5t ter er  de det t pr -to,3 and ,oon e7uit e7uit.. The ,o-t of the the ,oon e7uit for ea,h proe,t -hould e a-ed on the the et the proe,t. :ll e7uit Aill ,oe fro reine-ted earnin5-.

 

426 E7uit ine-ted in Proe,t : Aould hae a eta of 0.$. The proe,t ha- an epe,ted return of *.0'. *.0'. 4%6 E7uit ine-ted in Proe,t B Aould hae a eta of 1.0. The proe,t ha- an epe,ted return of 10.0'. 4)6 E7uit ine-ted in Proe,t C Aould hae a eta of 2.0. The proe,t ha- an epe,ted return of 11.0'. 11.0'. :nale the ,opanF,opanF- -ituation and eplain Ah ea,h proe,t -hould e a,,epted or ree,ted.

+ro9ect 4 +ro9ect . +ro9ect 8

.eta 0%" 1%0 &%0

r s

r ps %"0 1&%"0 1*%"0

11%00 11%00 11%00

r d(1 – T) !%"0 !%"0 !%"0

;xpected return on pro9ect 7488 8.2%' *' *.&%' 10' 12.&%' 11'

 

T