Answer the following two independent questions. a. MM Corporation is considering several proposed investments for the...

 

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Answer the following two independent questions. a. MM Corporation is considering several proposed investments for the coming budget year. MM produces electrical apparatus for industrial complexes. One proposal involves initiating a new line of business for MM, producing lighting systems for commercial properties. Consistent with MM's existing capital structure, the new commercial lighting project will be financed 75% with equity and 25% with debt. MM has a 10% cost of borrowing. In order to assess the proposed commercial lighting project for MM, a cost of capital must be estimated. A competitor of MM, BRYNA Inc., has an established commercial lighting division. It will be used as a proxy to determine an appropriate cost of capital for the MM project. BRYNA has 4 divisions. The divisions vary in size and in investment risk. Estimated market values (debt and equity), their book values and the betas of each division are shown in the Exhibit below. EXHIBIT BRYNA Inc. Data on Divisions Market Value ($mln) Division Commercial lighting Commercial security systems Residential lighting Residential security systems $25 30 25 45 Book Value ($mln) $20 $20 $15 $30 Beta 1.4 1.3 Question Calculate the weighted average cost of capital for the MM project proposal. 1.7 1.5 BRYNA allocates its capital to divisions according to its overall capital structure. Currently, the market value of BRYNA's debt is $70 million, its book value is $60 million and the tax rate is 40% for both companies. The expected return on the market is 15% and the risk free rate is 8%. b. [10 points] Quebec Inc, a retail firm, is making a decision on how much it should pay out to its stockholders. It has $100 million in investible funds. The following information is provided about the firm: - It has 100 million shares outstanding, each share selling for $15. The beta of the stock is 1.25 and the risk-free rate is 8%. The expected return on the market is 16%. - The firm has $ 500 million of debt outstanding. The marginal interest rate on the debt is 12%. - The corporation's tax rate is 50%. - The firm has the following investment projects: IRR Project ABC Investment Requirement 15 million 10 million 30 million 27% 20% 12% The firm plans to finance all its investment needs at its current debt ratio and the risk of the projects is similar to the firm. Question Should the company return money to its stockholders? If so, how much should be returned to stockholders? Answer the following two independent questions. a. MM Corporation is considering several proposed investments for the coming budget year. MM produces electrical apparatus for industrial complexes. One proposal involves initiating a new line of business for MM, producing lighting systems for commercial properties. Consistent with MM's existing capital structure, the new commercial lighting project will be financed 75% with equity and 25% with debt. MM has a 10% cost of borrowing. In order to assess the proposed commercial lighting project for MM, a cost of capital must be estimated. A competitor of MM, BRYNA Inc., has an established commercial lighting division. It will be used as a proxy to determine an appropriate cost of capital for the MM project. BRYNA has 4 divisions. The divisions vary in size and in investment risk. Estimated market values (debt and equity), their book values and the betas of each division are shown in the Exhibit below. EXHIBIT BRYNA Inc. Data on Divisions Market Value ($mln) Division Commercial lighting Commercial security systems Residential lighting Residential security systems $25 30 25 45 Book Value ($mln) $20 $20 $15 $30 Beta 1.4 1.3 Question Calculate the weighted average cost of capital for the MM project proposal. 1.7 1.5 BRYNA allocates its capital to divisions according to its overall capital structure. Currently, the market value of BRYNA's debt is $70 million, its book value is $60 million and the tax rate is 40% for both companies. The expected return on the market is 15% and the risk free rate is 8%. b. [10 points] Quebec Inc, a retail firm, is making a decision on how much it should pay out to its stockholders. It has $100 million in investible funds. The following information is provided about the firm: - It has 100 million shares outstanding, each share selling for $15. The beta of the stock is 1.25 and the risk-free rate is 8%. The expected return on the market is 16%. - The firm has $ 500 million of debt outstanding. The marginal interest rate on the debt is 12%. - The corporation's tax rate is 50%. - The firm has the following investment projects: IRR Project ABC Investment Requirement 15 million 10 million 30 million 27% 20% 12% The firm plans to finance all its investment needs at its current debt ratio and the risk of the projects is similar to the firm. Question Should the company return money to its stockholders? If so, how much should be returned to stockholders?

Answer rating: 100% (QA)

SOLUTION a To calculate the weighted average cost of capital WACC for the MM project proposal we need to calculate the cost of equity and the cost of ... View the full answer