Corporate Finance - Corporate Finance Section 2

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21. Gaven Warren at California Investment Advisors wants to estimate the cost of capital for Semiactive Conductors as well as projected cash flows for two of their projects to determine the effect of these new projects on the value of Semiactive Conductors. Warren has gathered following information on Semiactive Conductors:

 Current ($) )Target ($)
Book Value of Debt 6262
Market Value of Debt 5963
Book Value of Shareholder’s Equity78 88
Market Value of Shareholder’s Equity 230240

  • Option : B
  • Explanation : Use the market values of debt and equity to calculate their weights. wd = $63 / ($63 + $240) = 0.208 we = $240 / ($63 + $240) = 0.792.
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23. An optimal capital budget occurs when the marginal cost of capital:

  • Option : C
  • Explanation : An optimal capital budget occurs when the marginal cost of capital intersects the investment opportunity schedule.
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25. Information about a company is provided below. It is expected that the company will fund its capital budget without issuing any additional shares of common stock:

Source of capital  Capital structure proportionMarginal after-tax cost
Long-term debt 30%12%
Preferred stock 5%15%
Common equity 65%20%

  • Option : B
  • Explanation : The WACC of the company is calculated as follows: 0.3(12%) + 0.05(15%) + 0.65(20%) = 17.35%. To have a positive NPV, a project must have an IRR greater than the WACC used to calculate the NPV. Only the storage project has a NPV greater than $0 (at the company’s WACC of 17.35%), therefore only the storage project has an IRR that exceeds 17.35%.
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