1. What are the missing numbers for the below income statement? Revenues 100 Cost of Goods Sold ? Gross Margin 60 SG&A Expense ? Pre-tax Income 20 Tax Expense (40% of...

Answer both questions (50 points each: total = 100 points). Please show all work, including calculator keystrokes or Excel functions for time value of money calculations, so the maximum partial credit may be given.

1. The president of Receding Airlines has asked you to calculate the company's cost of capital. To start, you have gathered the following information:

(1) RecedingAir has the following securities outstanding:

· $1,000 face value, 8% annual coupon bonds with 15 years remaining to maturity and a current market price of $1,150.

· $100 par value preferred stock that pays an 11% annual dividend and has a current market price of $92.

· Common stock with a current market price of $50/share. Investors expect the next annual dividend to be $4.00 and to grow after that at a constant rate of 7% per year into the foreseeable future.

(2) If RecedingAir were to issue new securities today:

· New bonds would pay interest annually, have a 15-year life, and incur a flotation cost of 3%.

· A new issue of preferred stock would pay annual dividends and incur flotation costs of 6%

· A new issue of common stock would incur flotation costs of 8%.

(3) RecedingAir’s income is taxed at a 35% marginal rate.

(4) RecedingAir’s target capital structure is 35% long-term debt, 15% preferred stock, and 50% common equity.

(5) RecedingAir forecasts it will retain $25,000,000 of earnings in the coming year.

Required

a. What is the required rate of return of RecedingAir’s bondholders?

b. What is RecedingAir’s cost of debt?

c. What is the required rate of return of RecedingAir’s preferred stockholders?

d. What is RecedingAir’s cost of preferred stock financing?

e. What is the required rate of return of RecedingAir’s common stockholders?

f. What is RecedingAir’s cost of retained earnings financing?

g. What is RecedingAir’s cost of a new common stock issue?

h. What is RecedingAir’s weighted-average cost of capital (WACC) for its first dollar of new financing?

i. How much total new financing can RecedingAir raise before its supply of new retained earnings financing is exhausted and there is a break in the cost of capital schedule?

j. What would RecedingAir’s weighted-average cost of capital (WACC) become should it require more financing this year than the amount you calculated in part h, above?

2. You have just been hired by Edifice Wrecks, Inc. (the demolition company) to evaluate a proposal to purchase a new solar-powered, web-enabled building smasher to replace an existing hand-powered smasher. You have discovered that:

· The old hand-powered smasher was purchased 5 years ago for $90,000 and is being depreciated for tax purposes using the straight-line method over an 8-year life to a $10,000 salvage value. The old smasher’s salvage value remains $10,000, however, it could be sold today for $25,000. $15,000 is invested in working capital in support of this smasher.

· The new smasher would cost $125,000 and be depreciated for tax purposes using the straight-line method over a 3-year life to a salvage value of $5,000. With the new smasher, revenues are expected to increase from $4,000,000 to $4,055,000 in each of the next 3 years. At the end of the 3 years, the new smasher could be sold for its accounting salvage value of $5,000. The new smasher would require $25,000 in supporting working capital.

· The firm is in the 35% marginal income tax bracket and has a 13% cost of capital.

Required

a. Prepare the cash flow spreadsheet for the analysis of this project.

b. Calculate the project’s:

1) net present value (NPV)

2) internal rate of return (IRR)

c. Should the new smasher be purchased? Why or why not?