RED DRAGON plc is financed by equities and bonds, where bonds constitute 30% of the firm's...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
RED DRAGON plc is financed by equities and bonds, where bonds constitute 30% of the firm's market value. The bonds' coupon interest rate is 5% per annum, and their yield to maturity is 15% per annum. The beta of RED DRAGON's equity is 0.8. The stock market index has an expected return of 10% per annum (p.a.), the risk-free rate is 2% p.a., and the corporate tax rate is 40%. Today RED DRAGON plc is considering investing in a new project. There are two possible projects. PROJECT1 would cost £20 million immediately and will generate after-tax cash flows of £5 million exactly one year from now, and £10 million exactly two years from now, and £15 million exactly three years from now. PROJECT1 operates in the same industry and has the same business risk as those of RED DRAGON. PROJECT1's debt-to-equity ratio is 1. It has the same cost of debt as that of RED DRAGON. Assume that the beta of debt both for the company and for PROJECT1 are zero. PROJECT2 would cost £30 million immediately and will generate after-tax cash flows of £15 million exactly one year from now, and £20 million exactly two years from now. PROJECT2 operates in the same industry and has the same business risk as those of RED DRAGON. PROJECT2's debt-to-equity ratio is 2. It has the same cost of debt as that of RED DRAGON. Assume that the beta of debt both for the company and for PROJECT2 are zero. Calculate the following and show your full workings: (a) The asset beta of RED DRAGON (d) The cost of equity of PROJECT1 (e) The weighted average cost of capital of PROJECT1 (d) The cost of equity of PROJECT2 (e) The weighted average cost of capital of PROJECT2 [3 marks] [5 marks] [6 marks] [5 marks] [6 marks] (f) Calculate and justify whether RED DRAGON should invest in one of these two projects (if so, which one) or not. [10 marks] RED DRAGON plc is financed by equities and bonds, where bonds constitute 30% of the firm's market value. The bonds' coupon interest rate is 5% per annum, and their yield to maturity is 15% per annum. The beta of RED DRAGON's equity is 0.8. The stock market index has an expected return of 10% per annum (p.a.), the risk-free rate is 2% p.a., and the corporate tax rate is 40%. Today RED DRAGON plc is considering investing in a new project. There are two possible projects. PROJECT1 would cost £20 million immediately and will generate after-tax cash flows of £5 million exactly one year from now, and £10 million exactly two years from now, and £15 million exactly three years from now. PROJECT1 operates in the same industry and has the same business risk as those of RED DRAGON. PROJECT1's debt-to-equity ratio is 1. It has the same cost of debt as that of RED DRAGON. Assume that the beta of debt both for the company and for PROJECT1 are zero. PROJECT2 would cost £30 million immediately and will generate after-tax cash flows of £15 million exactly one year from now, and £20 million exactly two years from now. PROJECT2 operates in the same industry and has the same business risk as those of RED DRAGON. PROJECT2's debt-to-equity ratio is 2. It has the same cost of debt as that of RED DRAGON. Assume that the beta of debt both for the company and for PROJECT2 are zero. Calculate the following and show your full workings: (a) The asset beta of RED DRAGON (d) The cost of equity of PROJECT1 (e) The weighted average cost of capital of PROJECT1 (d) The cost of equity of PROJECT2 (e) The weighted average cost of capital of PROJECT2 [3 marks] [5 marks] [6 marks] [5 marks] [6 marks] (f) Calculate and justify whether RED DRAGON should invest in one of these two projects (if so, which one) or not. [10 marks]
Expert Answer:
Answer rating: 100% (QA)
a Asset beta of RED DRAGON Given Equity beta 08 Bonds constitute 30 of firm value Bond yield 15 Beta... View the full answer
Related Book For
Posted Date:
Students also viewed these finance questions
-
IF THE TARGET LIFE CYCLE PROFIT MARGIN IS 25%, HOW MUCH IS THE TOTAL MAXIMUM COST THAT DELAWARE CAN INCUR OVER THE THREE-YEAR MATURITY PHASE? Delaware Carnival Inc. will be offering a new ride in its...
-
Managing Scope Changes Case Study Scope changes on a project can occur regardless of how well the project is planned or executed. Scope changes can be the result of something that was omitted during...
-
KYC's stock price can go up by 15 percent every year, or down by 10 percent. Both outcomes are equally likely. The risk free rate is 5 percent, and the current stock price of KYC is 100. (a) Price a...
-
The cubic equation x 3 - x + 3 = 0 has roots , , . a. Using the relation S n , = n + n + n , or otherwise, find the value of S 4 . b. By considering S 1 and S 4 , determine the value of 3 ( + ) +...
-
How is the dictionary definition different from the accounting definition of depreciation?
-
Blockchain and cryptocurrency have great potential to bring prosperity into our world. The concept of a truly shared and democratic economy is at the core of the blockchain initiative. 1.) If you...
-
When is \(\mathrm{J}_{\mathrm{A}}=\mathrm{N}_{\mathrm{A}}\), and when are they not equal?
-
At December 31, 2012, the trial balance of Seidl Company contained the following amounts before adjustment. Instructions(a) Based on the information given, which method of accounting for bad debts is...
-
Blooming Flower Company was started in Year 1 when it acquired $60,000 cash from the Issue of common stock. The following data summarize the company's first three years' operating activities. Assume...
-
write a closed-research legal memo using the case cases given, addressing whether Mr. Adler can assert an adverse possession claim to Scrub Lot 40. Please write up your memo using the issue , brief...
-
The CEO knows that companies who recognize and reward team members have increased employee morale, lower turnover and increased productivity. Rewarding employees can increase business profit as much...
-
With yields near all time lows, why should investors own bonds? Explain how the article "Why Own Bonds When Yields Are So Low?" (link listed below) helps you better understand some of the more...
-
Answer +C Evaluate the indefinite integral. 4x-1 (4x - 2x+2)5 dx
-
What are the ethical implications and societal challenges associated with human-mediated adaptation strategies, such as assisted evolution and genetic engineering, aimed at enhancing resilience to...
-
What is meant by the intrinsic (investment) value of a stock? Write down the major characteristics of different types of bonds.
-
Explain how Amazon might conduct a financial cost-benefit analysis of two day delivery. How would this financial cost-benefit analysis differ from an economic cost-benefit analysis? What costs and/or...
-
What Internal Revenue Code section provides the basic formula for the calculation of gain or loss on the disposition of property? What is the formula for the computation of gain or loss? What is the...
-
Chris Zulliger was a chef at the Plaza Restaurant in the Snowbird Ski Resort in Utah. The restaurant is located at the base of a mountain. As a chef for the Plaza, Zulliger was instructed by his...
-
Nimby Corporation is considering two mutually exclusive projects: Delphi and Oracle. The possible NPVs for each project and their associated probabilities are as follows: Required: (a) Calculate the...
-
The directors of Tocantins Co. are considering whether to invest in two separate projects: one is small while the other is large. They are also trying to decide between two other competing projects....
-
The financial statements for Harridges plc are given below for each of the last two years ended 31 December. Harridges plc operates a large chain of retail stores. Dividends were paid on ordinary...
-
Whistle-blowers often question themselves as to whether they are doing the right thing. Terms such as snitch and tattletale are often associated with an individual who exposes wrongdoing. Do you...
-
The Claremont Corporation invests its excess cash in low-risk, dividend-paying equity securities until such funds are needed to support operations. At the beginning of the year, the companys...
-
The 2015 annual report of Bristol-Myers Squibb (BMS) reveals that the company maintains a large investment in available-for-sale securities: Did the companys available-for-sale securities experience...
Study smarter with the SolutionInn App