Each Fingame Team Member Will Receive the Same Grade

FinGame Assignment 4

Each FinGame Team Member will receive the same grade.

Kevin Lamberson

Jef Morgan

Monte Lawrence

For your Q5 decisions, download “Q5 Capital Budgeting Proj A or B Template” and rename the file “Q5CapitalBudgetingCOMPANYNAME”. Use the spreadsheet to determine whether you should invest in Project A and B.

1.  Before-tax cost of debt equals what percentage?

= 4.58%

2.  Your after-tax cost of debt equals what percentage?

= 2.75%

3.  Why is the before-tax cost of debt different than the after-tax cost of debt?

Since the interest payments are not tax deductible, the cost of debt must be stated on an after-tax basis

4.  Cost of capital (aka weighted average cost of capital) equals what percentage?

The WACC equals 4.50%.

5.  How does altering the capital structure change a company’s cost of capital?

Because of tax advantages on debt issuance, it will be cheaper to issue debt rather than new equity (only for profitable firms). At some point, however, the cost of issuing new debt will be greater than the cost of issuing new equity. This is because adding debt increases the risk - and the interest rate that the company must pay in order to borrow money. In the case of Quarter 5 fingame decisions, increasing the debt can lower the WACC.

Which form of capital is more expensive for a company, debt/bond or equity financing? Explain.

In the case of NewCo, in Quarter 5 we found that the more expensive form of capital is bonds. With short term loans, interest and the principle will be paid for in a shorter period of time. Contrasting with this fact, a company needs to pay a quarterly interest payment and the final par value of a bond. Therefore bonds can cost more in the long run, depending on the short term interest rates. (Higher short term interest rate loans can be more expensive than bonds.)

6.  What is the relevance of cost of capital? That is, why do we care what the cost of capital equals?

The cost acts as a major link between a firm’s long-term investment decision and the wealth of the stockholders. This number is used to decide whether a proposed investment will increase or decrease the firm’s stock price. Another way of stating this is the cost of capital is the rate of return that a firm earn on the projects in which it invest the market value of it stock

7.  Using IRR and NPV as your decision criteria, should you invest in Project A? Explain.

Yes, you should invest in project A due to the fact that the IRR (6.58%) is greater than the cost of capital (4.50%). In addition, the Net Present Value ($39,998) is greater than 0.

Send two files to the digital dropbox:

1) this completed Word file named “Assign4COMPANYNAME”

2) Excel file: “Q5CapitalBudgetingCOMPANYNAME”.