MULTI PART QUESTION PLEASE READ Your company XXX is looking

MULTI PART QUESTION- PLEASE READ.

Your company XXX is looking at YYY company to purchase it. The current price tag of YYY is $1.2 million. XXX has a beta of 1.5. The market is expected to have a return of 19% and the current 10-year t bond pays 3.5%. YYY company is expected to have cash flows of $250,000 in year one, $150,000 in year two, and $250,000 in year four. The YYY company is expected to grow at 5% indefinitely after that xxx company has a debt to equity ratio of 1/3 and a tax bracket of 35%. The cost of debt (before taxes) is estimated to be 796 What is the cost of equity for XXX company? (Points : 5) 26.75% 32.05% ? 23.25% 24.21% 29.77% What is XXX\'S WACC? (Points 5) 21.2% o 21.8% 28.3% O 22.5% 23.7% What is the \"approximate\" terminal vaue for YY for the 4th year (TV4)? O 1,620,370 O 1,238,208 O 1,543,209 O 1,667,559 O 1,728,466 What is the approximate NPV of purchasing YYY? O positive 23,807 O negative 24,819 O negative 20,478 O negative 819,909 O positive 102,574

Solution

1. According to the CAPM,

Re = Rf + beta(Rm - Rf)

= 3.5% + 1.5(19% - 3.5%) = 26.75%

Option \"A\" is correct.

2. WACC = Wd x Kd(1 - t) + We x Ke

= 0.25 x 7%(1 - 0.35) + 0.75 x 26.75% = 1.1375% + 20.0625% = 21.20%

Option \"A\" is correct.

3. Terminal Value (Year 4), TV4 = CF4(1 + g)/(WACC - g)

TV4 = $250,000(1.05)/(0.2120 - 0.05) = $262,000/0.162 = $1,620,370.37

Hence, Option \"A\" is correct.

4. NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

= $250,000/1.212¹ + $150,000/1.212² + $250,000/1.212⁴ + $1,620,370.37/1.212⁴ - $1,200,000

= $206,270.63 + $102,114.17 + $115,858.93 + $750,937.54 - $1,200,000

= -24,818.73

Option \"B\" is correct.