Assignment

 

Capital Budgeting Exercise

Interest Rate:    8%

Initial Cash Outflow

Year 0

($135,000)

Cash Inflows

Year 1

$25,000

Year 2

$40,000

Year 3

$18,000

Year 4

$52,000

Year 5

$32,000

Year 6

$43,000

Using the information in the chart above, calculate the following capital budgeting values:

Payback Method

Profitability Index (PI)

Net Present Value (NPV)

Internal Rate of Return (IRR)

1. Payback Method

Name one advantage and one disadvantage of using the using the payback method of capital budgeting.

2. Profitability Index (PI)

What is a major difference between using the payback method and the profitability index method of capital budgeting?

3. Net Present Value (NPV)

It is stated that with all of the various capital budgeting methods available to use that the net present value is the most reliable. Why is this the case?

4. Internal Rate of Return (IRR)

Due to the complexity of the calculation, it would seem the internal rate of return would be the most accurate of all capital budgeting methods. Why is this not the case?

Weighted Average Cost of Capital (WACC) Calculation

Using the data below, calculate the following values and use those inputs in the Weighted Average Cost of Capital formula to determine the WACC percentage for this company:

1. Equity: The Abbott Company has 10 million shares of common stock outstanding today. The current price of their company stock is $41.25. What is the value of the equity side of this firm?

$______________________                                    

2. Debt: The Abbott Company has 162,000 bonds in the marketplace. The current price of these bonds is 105% of par. What is the value of the debt side of this firm?

$______________________                                    

3. Total: Using the equity and debt totals from above, determine the total cost of capital.

$______________________                                    

4. Calculate the weighted percentage of the equity portion of the total cost of capital.

$______________________                                    

5. Calculate the weighted percentage of the debt portion of the total cost of capital.

$______________________                                    

6. The risk-free rate is currently 2.50%. If the expected market return is 8.50% and the beta of Abbott Company is 1.28, calculate the required rate of return using the Capital Asset Pricing Model (CAPM) formula.

______________________                                      

7. If the tax rate of The Abbott Company is 26%, what is the factor to use to calculate the after-tax rate percentage in the WACC formula?

______________________                                      

8. The Abbott Company's bond yield is currently at 5.50%. Using the after-tax factor from the above question, determine the after-tax debt rate of return.

______________________                                       

9. You now have developed all of the inputs necessary to calculate Abbott Company's WACC percentage. Showing your work, calculate this percentage.

_______________________________________________________________________________

_______________________________________________________________________________

WACC = ______________________