Cargo Corporation is a major producer of lawn care products. Cargo stock currently sells for RM80 per share; there are 10.5 million shares outstanding. Cargo also has debt outstanding with an aggregate book value of RM400 million. The bonds issued by Cargo are currently yielding 10% and are trading at 90% of face value. The risk-free rate if 8%, the market risk premium is 9%, and Cargo has a beta equal to 2. The corporate tax rate is 34%.

(a) Cargo is considering expansion of its facilities. Use the SML approach to determine the cost of equity capital for Cargo.

(b) Compute the weighted average cost of capital for Cargo.

(c) The project under consideration requires an outlay of RM1,000,000. The expansion will produce incremental aftertax cash inflows of RM350,000 per year for the next five years. Compute the net present value of the investment, assuming the project has the same risk as Cargo’s other projects.

(d) Flotation costs are 5% of the amount of common stock issued and 2% of the amount of debt issued. Using the same data, compute the weighted average flotation cost for Cargo. Then, compute the net present value of the investment when flotation costs are considered to determine whether they should undertake the project.

 

Answer rating: 100% (QA)

a Cost of equity using CAPM Risk free rate 8 Market risk premium 9 Beta of Cargo 2 Cost of equity Ri... View the full answer