1. You find a project that has the following characteristics. It would cost $10,000 initially. The project could be depreciated to zero over 10 years, in a straight line. Initial revenues would be $10,000 in 1 year and would grow at 5% per year after that. Cash costs would we 60% of revenue. The project would require a level of inventory equal to 50% of the coming year’s sales. That means that the initial investment in inventory would be $5000 at time t=0. The project would be sold in 5 years for $7000. At that point the inventory would be liquidated. The tax rate is 40% and the discount rate (WACC) is 15%. Find the present value of the project.
2. A company has 1 million shares outstanding with a share price of $10 per share. In addition the
company has $5 million of debt that yields 6%. The market value of the company’s debt is equal to its par value. The risk free rate is 2% and the market risk premium is 5% and the company’s beta is 2. The company’s tax rate is 50%. First, calculate the market value of the equity and then determine the weights of equity and debt in the capital structure. Then use CAPM to determine a cost of equity (required return for equity holders). Finally determine WACC.
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