Chapter 4:

Exercise 4.3:
Calculating a Firms WACC Xoong Enterprises is estimating its cost of capital for the first time
and has made the following estimates: The firms debt carries a AAA rating, which is currently
yielding 8%; the firm pays taxes at a rate of 35%; the cost of equity is estimated to be 14%; and
the firms debt is equal to 25% of its enterprise value.
a. What is Xoongs estimated WACC?
b. If Xoong were to increase its debt level to 43% of enterprise value, the firms investment
banker has told the firm that its credit rating would drop to AA and correspondingly its cost of
debt financing would reduce to 7%. If the cost of equity corresponding to this new capital
structure were to rise to 16%, what would be the firms estimated WACC?
Exercise 4.4:
In December of 2005, the Eastman Kodak Corporation (EK) had a straight bond issue
outstanding that was due in four years. The bonds are selling for $1,092 with the face value of
$1,000 and pay a quarterly interest payment based on a 8% (annual) coupon rate of interest.
Assume that the bonds remain outstanding until maturity and that the company makes all
promised interest and principal payments in a timely basis. What is the YTM to maturity to the
bond holders in December of 2005?

Exercise 4.6:
Calculating the Cost of Equity Smaltz Enterprises is currently involved in its annual review of
the firms cost of capital. Historically, the firm has relied on the CAPM to estimate its cost of
equity capital. The firm estimates that its equity beta is 1.05, and the yield to maturity on long-
term US Treasury bonds is 5.38%. The firms CFO is currently in a debate with one of the firms
advisers at its investment bank about the level of the market risk premium. Historically, Smaltz
has used 8% to approximate the market risk premium. However, the investment banker argues
that this premium has shrunk dramatically in recent years and is more likely to be in the 3% to
5% range.
a. Estimate Smaltzs cost of equity capital using a market risk premium of 4% and 8%.
b. Smaltzs capital structure is comprised of 75% equity (based on current market prices) and
35% debt on which the firm pays a yield of 4.125% before taxes at 20%. What is the firms
WACC in both cases of market risk premium?
Exercise 4.9*:
The CT Computers Corporation is considering whether to begin offering customers the option to
have their old personal computers (PCs) recycled when they purchase new systems. The recycling
system would require CT Computers to invest $500,000 in the grinders and magnets used in the
recycling process. The company estimates that for each system it recycles, it would generate $1.50
in incremental revenues from the sale of scrap metal and plastics, and the unit cost of disposal is
$0.2. The machinery has a five-year useful life and will be depreciated using straight-line
depreciation toward a zero salvage value. CT Computers estimates that in the first year of the
recycling investment, it could recycle 50,000 PCs and that this number will grow by 25% per year
over the remaining four-year life of the recycling equipment. CT Computers uses a 10% discount
rate to analyze capital expenditures and pays taxes equal to 30%.
a. What are the project cash flows? You can assume that the recycled PCs cost CT Computers
nothing.
b. Calculate the NPV and IRR for the recycling investment opportunity. Is the investment a good
one based on these cash flow estimates?
Exercise 4.10*:
Glentech Manufacturing is considering the purchase of an automated parts handler for the
assembly and test area of its Phoenix, Arizona, plant. The handler will cost $250,000 to purchase
plus $10,000 for installation. The initial investment in the handler will be depreciated using
straight-line depreciation over ten years with zero-salvage value. If the company undertakes the
investment, it will automate part of the semiconductor test area and reduce operating costs by
$70,000 per year for the next five years. Glentechs tax rate is 30%, and its opportunity cost of
capital is 12%. The project life is 5 years.
a/ Make the depreciation table
b/ Is this a good project for Glentech? Explain your answer.