Reference no: EM132863291

Question - Assume that you have been hired as a consultant by KeepCalm Co., a major producer of apparels in Southeast Asia, from kids' wear to sports' apparels, to estimate the firm's weighted average cost of capital and the impact of their plan to change the capital structure. The balance sheet and some other information are provided below.

Assets

Current assets $29,000,000

Net plant, property, and equipment 105,000,000

Total assets $134,000,000

Liabilities and Equity

Accounts payable $8,000,000

Accruals 6,000,000

Current liabilities $14,000,000

Long-term debt (36,000 bonds, $1,000 par value) 36,000,000

Total liabilities $50,000,000

Common stock (5,000,000 shares) 40,000,000

Retained earnings 44,000,000

Total shareholders' equity 84,000,000

Total liabilities and shareholders' equity $134,000,000

The stock is currently selling for $17.224 per share, and its noncallable $1,000 par value, 10-year, 10% bonds with semiannual payments are selling for $1,080.00.

The beta is 1.30 while the real risk-free rate is(R*) is 2%. Inflation rates will be 3% during the first two years and 5% on the years thereafter. Treasury bonds are expected to have .10(T-1)% of maturity risk premium(MRP). The required return on the stock market is 10.50%, but the market has had an average annual return of 13.50% during the past 5 years. The firm's tax rate is 30%.

KeepCalm is expected to issue P1.25 worth of dividend per share at the end of the year with a constant growth of 5% each year.

Required -

1) What is the Treasury Bill and Treasury Bond rate?

2) What is the YTM and the after-tax cost of debt?

3) Using CAPM, what is the required rate of return of KeepCalm stocks?

4) Using DCF approach, what is the expected rate of return of KeepCalm stocks if the retained earnings is sufficient to support the capital budget requirement?

5) Using DCF approach, what is the expected rate of return of KeepCalm stocks if the retained earnings is insufficient to support the capital budget requirement and the flotation rate is at 12%?

6) Using Bond-Yield-Plus-Risk-Premium Approach with the 3% risk premium, what is the estimated cost of equity?

7) What is the WACC assuming you have equal confidence with all the cost of equity approaches and the retained earnings is sufficient to support the capital budget requirement?

8) Assuming the company would like to change its capital structure to 40% debt and 60% equity, what will be new levered beta? (Remember to compute first the unlevered beta)

9) Using the new levered beta, what is the new WACC?

10) Should the company change its capital structure? Why or why not?

11) Assuming the company would like to invest in a machinery which will cost P880,000 and will provide an inflow of P200,000 for each of its6 year life, what is the company's payback and

12) Using the information above, what is the projects NPV and Profitability index? Should it be accepted or not?

13) What is the projects IRR?