Security Outstanding Particulars
ong-term debt $85,000,000 (par) due in 9 years 3.3% coupon payable annually, with a market yield of 10.7%
Preferred stock $32,000,000 (par) Nominal value per share $100, with a current market price of $105.5 per share; dividend rate = 4.5% p.a.
Common stock 39,000,000 shares Par value of $1, market price of $4.8 per share; beta of 1.05.
The appropriate corporate tax rate is 30%. The market risk premium is 6% while the risk-free rate is 3%. Assume the CAPM holds.
Johnson land is considering diversifying into property management of its developed properties. This requires an initial investment of $8.5 million to be financed internally, and will generate zero cashflow for Years 1 and 2, after-tax cashflow of $500,000 from Year 3, with a growth of 3% per year forever. Listed property management firms have a beta of 0.3, and are debt free. Johnson land finance trainee David said that the proposed project has a negative NPV.
1. Assess the capital structure of Johnson land on a market value basis.
2. Calculate the weighted average cost of capital (WACC) of Johnson land.
3. Is the risk of the property management project the same as that of Johnson land? Should Johnson land undertake this new project based on the NPV analysis? Justify your answer.
4. A survey shows that the most commonly used discount rate in capital budgeting is (11 marks) the company’s cost of capital. Discuss the pros and cons of using the WACC for capital budgeting decisions