15 Jun Question Chapter 6 – Questions
Question
Chapter 6 – Questions
1. List some of the factors which make debt less expensive than equity.
2. Explain the tax-effect upon the cost of debt.
3. Why might a hotel project have a higher interest rate than a single-family home loan?
4. What is Internal Capital and how should it be priced when computing WACC?
5. What is the Yield Curve and what can it tell you about the stock market’s prospects?
Chapter 6 – Equity Partner Return
Listed below is an example of the Return on Equity calculation for a $300,000 project with $210,000 of debt @ 10% and $90,000 of equity @ 30% of net cash flow. The cash flow is $81,000.
6. Calculate the Return on Equity for an equity partner who receives 35% of the net cash flow of a $1,500,000 project with 70% of debt @ 12%. The projected cash flow is $560,000.
7. Calculate the Return on Equity for an equity partner who receives 25% of the net cash flow of a $1,200,000 project with 60% of debt @ 9%. The projected cash flow is $420,000.
Chapter 6 – WACC (Known ROE)
Listed below is an example of a Weighted Average Cost of Capital (WACC) calculation for a $200,000 project financed by $120,000 of debt @ 12% and $80,000 of equity at 25%. The tax rate is 33%.
$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt $1,20,000 60.0% 12.0% 33.0% 8.0% 4.8%
Equity $80,000 40.0% 25.0% 33.0% 25.0% 10.0%
Total $2,00,000 100.0% 14.8%
8. Calculate the WACC for a $450,000 project, 70% financed by debt @ 9% and the balance by equity at 19%. The tax rate is 28%.
$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
9. Calculate the WACC for a $1,600,000 project, 65% financed by debt @ 13% and the balance by equity at 24%. The tax rate is 31%.
$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
Chapter 6 – WACC (ROE from Share of Cash Flow)
10. Calculate the Return on Equity for an equity partner who receives 27% of the net cash flow of a $2,200,000 project with 65% of debt @ 11%. The projected cash flow is $620,000. The tax rate is 32%
Item Calculation Result
Project Cash Flow Project Cash Flow
Interest Cost Interest Cost
Net Cash Flow Net Cash Flow
Equity Partner Share Equity Partner $ Share
Cost of Equity Return on Equity
11. Now calculate the WACC for that project.
$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
Chapter 6: Conversion of Historic Bank to Hotel (pg 175)
The Williams Bennett Hotel Development Co. has identified an historic bank building that could be converted into a hotel. The location is in the heart of downtown Smithton, a densely populated city. The structure was designed by an acclaimed architect and built in 1913. The fifteen-story will be transformed into a chic boutique hotel with the hotel lobby, meeting rooms, cafe and fitness area on the first two floors. The remaining thirteen floors will contain 130 guest rooms. The entire project will cost $35,000,000. 60% of the project will be financed with debt and $14 million is being provided by equity investors. The lender is offering a loan at a 12% interest rate and the equity investors are requiring a return of 18% on their investment. The current business tax rate is 25%. Because the structure is an historic landmark, the development company has been in discussions with government agencies to determine if there are any public incentives for redeveloping the property. The hotel market in Smithton is underserved and the city needs additional rooms to attract larger convention groups. The city would also gain additional jobs which would lower the unemployment rate and a spur to the local retail and restaurant market from the new guests.
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