Suppose the discount rate for the bond is given

Information:
a. Answer all questions.
b. Always explain your answers with clear statements.
1. Company AFLAC had issued a 12-year coupon bond with 8% coupon rate on the face value as
$1,000 and with semi-annual payments. Currently, the company has $4 million in debts. Answer
the following questions:
a) Suppose the discount rate for the bond is given as 10%, what is the present value of the bond?
b) Suppose the current market price of the bond is given as $906 per bond, what is the current
market discount rate (or so called Yield to Maturity) for the bond?
c) The company also issued a common stock of $0.45 dividend with 10% growth rate for the
coming 3 years and possibly smoothed out toward 5% from the 4 th year and on. There is also one
preferred stock issued with preferred dividend as $1.2 and preferred stock price as $10 per share.
The current common stock price is $14.20/ per share, the corporate income tax rate is 25%. What
is the Weighted Average Cost of Capital (WACC) for Company AFLAC if there are 5 million
share of common stock issued and 1 million shares of preferred stock issued?
d) What are the assumptions for Weighted Average Cost of Capital (WACC)?
2. You are given with the following information of two projects planned by your company. Two
projects are of the same initial costs with $2 millions.
Project
A
B

Year 1
-220
-206

Table 1: (in thousands)
Year 2
Year 3
720
-180
915
1600

Year 4
1000

Year 5
1800

Answer the following questions.
a) Suppose the weighted average cost of capital is 10%. What are the Net Present Values for these
two projects? Which project is better? What are the limitations for this criterion?
b) Suppose the financial manager discovered that if we postponed the project B to two years later,
the cost of capital could be 8% due to possible low future interest rates. However, the
deferment may cost the firm additional $0.5 million to restart the facilities and the initial cost
must be spent now, instead of two years later. Will you recommend waiting for additional 2
years to start?
c) Let the corporate income tax rate be 30%, the cost of debts be 6%, the cost of equity be 25%
and there is no preferred stock issued by the firm. What is the debt-to-equity ratio for your
company if the cost of capital is given as in a)?
d) Find the IRR (Internal Rate of Return) for project A and project B. Which project will you
choose? What are the limitations for this criterion?
3. You are given with the following information of two projects planned by your company when
there is no consideration of the possible bad condition of economy. Two projects are of the same
initial costs with $1 million.
Project
A

Year 1
850

Table 1: (in thousands)
Year 2
Year 3
2720
- 250

Year 4
1300

Year 5
2800

B

1460

-375

1600

Answer the following questions.
a) Suppose the cost of capital is 10% and the $1 million initial outlays are paid out by
installments, that is, the $1 million initial outlays are present values for the regular payments each
year, what is the Net Present Value for each project?
b) Suppose the financial manager discovered that if we postponed the project B to two years later,
the cost of capital could be 9% due to possible low future interest rates. However, the deferment
may cost the firm additional $350,000 to restart the facilities and the initial outlay must be spent
now, instead of two years later. Will you recommend waiting for additional 2 years to start?
c) Let the corporate income tax rate be 30%, the cost of debts be 6%, the cost of equity be 25%
and there is no preferred stock issued by the firm. Assuming the weighted average cost of capital
is given as 12% in a), what is the debt-to-equity ratio for your company?
d) Find the IRR (Internal Rate of Return) for project A and project B. What is your decision based
on the IRR criterion?
Project
A
B

Year 1
-650
160

Year 2
720
1875

Year 3
-450
-1000

Year 4
-2100

Year 5
-500