PROBLEM AND ANSWER

1. COST OF COMMON EQUITY. Percy Motors has a target capital structure of 40% debt and 60%
common equity, with no preferred stock. The yield to maturity on the company’s outstanding bonds
is 9%, and its tax rate is 40%. Percy’s CFO estimates that the company’s WACC is 9.96%. What is
Percy’s cost of common equity ?

Answer :
40% Debt; 60% Common equity; rd = 9%; T = 40%; WACC = 9.96%; rs = ?
WACC = (wd)(rd)(1 – T) + (wc)(rs)
0.0996 = (0.4)(0.09)(1 – 0.4) + (0.6)rs
0.0996 = 0.0216 + 0.6rs
0.078 = 0.6rs
rs = 13%.

2. COST OF EQUITY AND WITHOUT FLOATATION. Javits & Sons’ common stock currently trades at
$30.00 share. It is expected to pay an annual dividend of $3.00 a share at the end of the year (D1 =
$3.00), and the constant growth rate is 5% a year.
a) What is the company’s cost of common equity if all of its equity comes from retained earnings?
b) If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of
equity from new stock?

Answer :
P0 = $30; D1 = $3.00; g = 5%; rs = ?
D1 $3.00
a. rs = +g= + 0.05 = 15%.
P0 $30.00
b. F = 10%; re = ?
D1 $3.00
re = +g = + 0.05
P0 (1  F) $30(1  0.10)
$3.00
= + 0.05 = 16.11%.
$27.00

3. COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION. The Evanec Company’s next
expected dividend, D1, is $3.18; its growth rate is 6%; and its common stock now sells for $36.00.
New stock (external equity) can be sold to net $32.40 per share.
a. What is Evanec’s cost of retained earnings, rs ?
b. What is Evanec’s percentage flotation cost, F?
c. What is Evanec’s cost of new common stock, re ?

Answer :
D1
a) rs = +g
P0

$3.18
= + 0.06
$36
= 14.83%.
 b) F = ($36.00 – $32.40)/$36.00 = $3.60/$36.00 = 10%.
c) re = D1/[P0(1 – F)] + g = $3.18/$32.40 + 6% = 9.81% + 6% = 15.81%

4. WACC. Midwest Electric Company (MEC) uses only debt and equity. It can borrow unlimited
amounts at an interest rate of (rd) 10% as long as it finances at its target capital structure, which
calls for 45% debt and 55% common equity. Its last dividend (D0) was $2, its expected constant
growth rate is 4 percent, and its stocksells at a price of $20. MEC’s tax rate is 40 percent. Two
projects are available: Project A has a rate of return of 13%, while Project B has a rate of return of 10
percent. All of the company’s potential projects are equally risky and as risky as the firm’s other
assets.
a. What is MEC’s cost of common equity?
b. What is MEC’s WACC?
c. Which projects should MEC select?

Answer :
a) rd = 10%, rd(1 – T) = 10%(0.6) = 6%.
D/A = 45%; D0 = $2; g = 4%; P0 = $20; T = 40%.
Project A: Rate of return = 13%.
Project B: Rate of return = 10%.
rs = $2(1.04)/$20 + 4% = 14.40%.

b) WACC = 0.45(6%) + 0.55(14.40%) = 10.62%.

c) Since the firm’s WACC is 10.62% and each of the projects is equally risky and as risky as the
firm’s other assets, MEC should accept Project A. Its rate of return is greater than the firm’s
WACC. Project B should not be accepted, since its rate of return is less than MEC’s WACC.

5. IRR AND NPV. A company is analyzing two mutually exclusive projects, S and L, whose cash flows
areshown below:

The company’s WACC is 10%. What is the IRR of the better project? (hint : The better project may or
may not be the one with the higher IRR)

Answer :

Input the appropriate cash flows into the cash flow register, and then calculate NPV at 10% and the
IRR of each of the projects:

Project S: CF0 = -1000; CF1 = 900; CF2 = 250; CF3-4 = 10; I/YR = 10. Solve for NPVS = $39.14; IRRS
= 13.49%.
 Project L: CF0 = -1000; CF1 = 0; CF2 = 250; CF3 = 400; CF4 = 800; I/YR = 10. Solve for NPVL =
$53.55; IRRL = 11.74%.

Since Project L has the higher NPV, it is the better project, even though its IRR is less than Project S’s
IRR. The IRR of the better project is IRRL = 11.74%.

6. MIRR. A firm is considering two mutually exclusive projects, X and Y, with the following cash flows :
0 1 2 3 4
| | | | |
Project X -1,000 100 300 400 700
Project Y -1,000 1,000 100 50 50

The projects are equially risky, and their WACC is 12%. What is the MIRR of the project that
maximizes shareholder value?
Answer :

Project X: 0 12%
1 2 3 4

| | | | |

-1,000 100 300 400 700.00

 1.12

 (1.12)2
448.00

376.32
 (1.12)3

140.49

1,000 13.59% = MIRRX1,664.81

$1,000 = $1,664.81/(1 + MIRRX)4

Project Y: 0 12%
1 2 3 4

| | | | |

-1,000 1,000 100 50 50.00

 1.12

 (1.12)2
56.00

125.44
 (1.12)3

1,404.93

1,000 13.10% = MIRRY 1,636.37

$1,000 = $1,636.37/(1 + MIRRY)4.

Thus, since MIRRX > MIRRY, Project X should be chosen.

 Alternate step: You could calculate the NPVs, see that Project X has the higher NPV, and just
calculate MIRRX.

NPVX = $58.02 and NPVY = $39.94.

7. CAPITAL BUDGETING CRITERIA. A Company has 12% WACC and is considering two mutually
exclusive investments (that cannot be repeated) with the following cash flows :

a) What is each project’s NPV?

b) What is each project’s IRR?
c) What is each project’s MIRR? (Consider period 7 as the end of Project B’s life)
d) From your answers to Parts a,b, and c, which project would be selected? If the WACC was
18%, which project would be selected?

Answer :

1. Using a financial calculator and entering each project’s cash flows into the cash flow registers
and entering I/YR = 12, you would calculate each project’s NPV. At WACC = 12%, Project A
has the greater NPV, specifically $200.41 as compared to Project B’s NPV of $145.93.

2. Using a financial calculator and entering each project’s cash flows into the cash flow
registers, you would calculate each project’s IRR. IRRA = 18.1%; IRRB = 24.0%.

3. Here is the MIRR for Project A when WACC = 12%:

PV costs = $300 + $387/(1.12)1 + $193/(1.12)2 + $100/(1.12)3 + $180/(1.12)7 = $952.00.

TV inflows = $600(1.12)3 + $600(1.12)2 + $850(1.12)1 = $2,547.60.

MIRR is the discount rate that forces the TV of $2,547.60 in 7 years to equal $952.00.

Using a financial calculator enter the following inputs: N = 7, PV = -952, PMT = 0, and FV =
2547.60. Then, solve for I/YR = MIRRA = 15.10%.
 Here is the MIRR for Project B when WACC = 12%:
PV costs = $405.

TV inflows = $134(1.12)6 + $134(1.12)5 + $134(1.12)4 + $134(1.12)3 + $134(1.12)2 + $134(1.12)

= $1,217.93.

MIRR is the discount rate that forces the TV of $1,217.93 in 7 years to equal $405.

Using a financial calculator enter the following inputs: N = 7; PV = -405; PMT = 0; and FV =
1217.93. Then, solve for I/YR = MIRRB = 17.03%.

4. WACC = 12% criteria:

Project A Project B
NPV $200.41 $145.93
IRR 18.1% 24.0%
MIRR 15.1% 17.03%

The correct decision is that Project A should be chosen because NPVA > NPVB.

At WACC = 18%, using your financial calculator enter the cash flows for each project, enter
I/YR = WACC = 18, and then solve for each Project’s NPV.

NPVA = $2.66; NPVB = $63.68.

At WACC = 18%, NPVB > NPVA so Project B would be chosen.

8. NEW PROJECT ANALYSIS. You must evaluate the purchase of spectrometer for the R&D
department. The base price is $140,000, and it would cost another $30,000 to modify the equipment
for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after
3 years for $60,000. The applicable depreciation rates are 33%, 45%, 15% and 7% as discussed in
Appendix 13A. The equipment would require an $8,000 increase in net operating working capital
(spare parts inventory). The project would have no effect on revenues, but it should save the firm
$50,000 per year in before-tax labor costs. The firm’s marginal federal-plus-state tax rate is 40%.
a) What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash
flow?
b) What are the project’s annual cash flow in Years 1, 2, and 3?
c) If the WACC is 12%, should the spectrometer be purchased? Explain.

Answer :

a) The net cost is $178,000:

Cost of investment at t = 0:
Base price ($140,000)
Modification (30,000)
Increase in NWC (8,000)
Cash outlay for new machine ($178,000)
 b) The annual cash flows follow:
Year 1 Year 2 Year 3
After-tax savings $30,000 $30,000 $30,000
Depreciation tax savings 22,440 30,600 10,200
Salvage value $60,000
Tax on SV (19,240)
Return of NWC 8,000
Project cash flows $52,440 $60,600 $88,960

Notes:
1. The after-tax cost savings is $50,000(1 – T) = $50,000(0.6) = $30,000.
2. The depreciation expense in each year is the depreciable basis, $170,000, times the
MACRS allowance percentages of 0.33, 0.45, and 0.15 for Years 1, 2, and 3, respectively.
Depreciation expense in Years 1, 2, and 3 is $56,100, $76,500, and $25,500. The
depreciation tax savings is calculated as the tax rate (40%) times the depreciation
expense in each year.
3. Tax on SV = ($60,000 – $11,900)(0.4) = $19,240.

c) The project has an NPV of ($19,549). Thus, it should not be accepted.

Year Cash Flow PV @ 12%
0 ($178,000) ($178,000)
1 52,440 46,821
2 60,600 48,310
3 88,960 63,320
NPV = ($ 19,549)
Alternatively, place the cash flows on a time line:

0 12%
1 2 3
| | | |
-178,000 52,440 60,600 40,200
48,760
88,960
With a financial calculator, input the cash flows into the cash flow register, I/YR = 12, and then
solve for NPV = -$19,548.65  -$19,549.

9. RESIDUAL DIVIDEND MODEL. Bumiputra Corporation is reviewing its capital budget for the
upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, and its
shareholders expect the dividend to remain constant for the next several years. The company’s
target capital structure is 60% equity and 40% debt, it has 1,000,000 shares of common equity
outstanding, and its net income is $8 million. The company forecasts that it will require $10 million
to fund all of its profitable (that is, positive NPV) projects for the upcoming year.
a) If Bumiputra follows the residual dividend model, how much retained earnings will it need to
fund its capital budget?
 b) If Bumiputra follows the residual dividend model, what will e the company’s dividend per share
and payout ratio for the upcoming year?
c) If Bumiputra maintains its current $3.00 DPS for next year, how much retained earnings will be
available for the firm’s capital budget?
d) Can the company maintain its current capital structure, the $3.00 DPS, and a $10 million capital
budget without having to raise new common stock?

Answer :
a) Capital budget = $10,000,000; Capital structure = 60% equity, 40% debt; Common shares
outstanding = 1,000,000.
Retained earnings needed = $10,000,000(0.6) = $6,000,000.

b) According to the residual dividend model, only $2 million is available for dividends.
NI – Retained earnings needed for capital projects = Residual dividend
8,000,000 – $6,000,000 = $2,000,000.

DPS = $2,000,000/1,000,000 = $2.00.

Payout ratio = $2,000,000/$8,000,000 = 25%.

c) Retained earnings available = $8,000,000 – $3.00(1,000,000)

= $5,000,000.

d) No. If the company maintains its $3.00 DPS, only $5 million of retained earnings will be available
for capital projects. However, if the firm is to maintain its current capital structure $6 million of
equity is required. This would necessitate the company having to issue $1 million of new
common stock.

10. Soal Kuis Terkahir 1. PT. Tundra Jaya ingin menentukan struktur kapital yang paling optimal yang
saat ini terdiri atas utang dan saham biasa. Saat ini perusahaan tidak menggunakan saham preferen
dalam struktur kapitalnya, dan tidak berencana untuk melakukannya dalam waktu dekat. Setelah
berkonsultasi dengan pihak investasi dari Bank, staff bagian keuangan PT. Tundra Jaya membuat
skema yang menunjukan skema biaya utang pada tingkatan yang berbeda yaitu sebagai berikut :

Debt to Equity to Debt to Before-Tax

Bond
Capital Capital Equity Cost of Debt
Rating
(Wd) Ratio (Wc) (D/E) (rd)
0.00 1.00 0.00 A 7.0%
0.20 0.80 0.25 BBB 8.0%
0.40 0.60 0.67 BB 10.0%
0.60 0.40 1.50 C 12.0%
0.80 0.20 4.00 D 15.0%
PT. Tundra Jaya menggunakan CAPM untuk mengestimasi jumlah total dari biaya saham biasa, rs,
dan risk-free rate 5%, market risk premium 6%, dan tax rate 25%. Apabila perusahaan tidak memiliki
utang, besar dari unlevered beta (bu) adalah 1.2

Dari informasi diatas, jawablah pertanyaan berikut ini :

a) Hitunglah berapa struktur kapital paling optimal (optimal capital structure) PT. Tundra Jaya,
dan berapakah besarnya WACC dalam kondisi optimal tersebut?
(Anda diminta menghitung levered beta menggunakan Hemada Equation, rs, dan WACC)
b) Pihak Manajemen PT. Tundra Jaya mengantisipasi peningkatan risiko bisnis di masa yang
akan datang. Bagaimana dampak peningkatan resiko bisnis tersebut terhadap struktur
kapital optimal perusahaan?
c) Apabila pemerintah memutuskan untuk meningkatkan tarif pajak hingga dua kali lipat,
bagaimana dampaknya terhadap struktur kapital optimal perusahaan?

Jawaban :

1. Diketahui : Tax rate = 25%; rRF = 5.0%; bU = 1.2; rM – rRF = 6.0%

Befor
Equity Debt
Debt e-Tax Leve
to to
Scen to Bond Cost rage
Capita Equit rd (1-T) rsb WACC
ario Capital Rating of d
l Ratio y
(Wd) Debt Beta
(Wc) (D/E)
(rd)
1 0.00 1.00 0.00 A 7.0% 5.25% 1.20 12.20% 12.20%
2 0.20 0.80 0.25 BBB 8.0% 6.00% 1.43 13.55% 12.04%
3 0.40 0.60 0.67 BB 10.0% 7.50% 1.80 15.82% 12.49%
4 0.60 0.40 1.50 C 12.0% 9.00% 2.55 20.30% 13.52%
5 0.80 0.20 4.00 D 15.0% 11.25% 4.80 33.80% 15.76%
RUMUS
Leveraged Beta dengan Hamada Equation, bL = bU[1 + (1 – T)(D/E)]
rsb (rs estimate) dengan CAPM, rs = rRF + (rM – rRF)b
WACC calculation, WACC = wd(rd)(1 – T) + (wc)(rs).

Struktur kapital yang paling optimal PT. Tundra Jaya dapat diambil pada skenario yang
memiliki WACC paling rendah, yaitu skenario nomor 2 dengan 20% hutang dan 80% modal,
WACC yang dihitung untuk skenario 2 adalah 12.04%.

2. Apabila resiko bisnis meningkat, PT. Tundra jaya sebaiknya tetap menjaga proporsi hutang
(debt) lebih sedikit dari proporsi modal (equity).
Hal ini dibuktikan apabila Market Risk Premium naik dari 6% menjadi 8%, struktur kapital
optimal dengan WACC paling rendah 14.32% (pada tabel dibawah) tetap pada skenario 2
dengan 20% debt dan 80% equity.
 Equity Before-
Debt Debt
to Tax Levera
to to Bond rd (1-
Scenario Capital Cost of ged rsb WACC
Capital Equity Rating T)
Ratio Debt Beta
(Wd) (D/E)
(Wc) (rd)
1 0.00 1.00 0.00 A 7.0% 5.25% 1.20 14.60% 14.60%
2 0.20 0.80 0.25 BBB 8.0% 6.00% 1.43 16.40% 14.32%
3 0.40 0.60 0.67 BB 10.0% 7.50% 1.80 19.42% 14.65%
4 0.60 0.40 1.50 C 12.0% 9.00% 2.55 25.40% 15.56%
5 0.80 0.20 4.00 D 15.0% 11.25% 4.80 43.40% 17.68%

3. Apabila tarif pajak naik 2 kali lipat dari 25% menjadi 50% :
Diketahui : Tax rate = 50%; rRF = 5.0%; bU = 1.2; rM – rRF = 6.0%

Equity Debt Before-

Debt to to to Bond Tax Levera
Scenari rd (1-
Capital Capita Equit Ratin Cost of ged rsb WACC
o T)
(Wd) l Ratio y g Debt Beta
(Wc) (D/E) (rd)
1 0.00 1.00 0.00 A 7.0% 3.50% 1.20 12.20% 12.20%
2 0.20 0.80 0.25 BBB 8.0% 4.00% 1.35 13.10% 11.28%
3 0.40 0.60 0.67 BB 10.0% 5.00% 1.60 14.61% 10.77%
4 0.60 0.40 1.50 C 12.0% 6.00% 2.10 17.60% 10.64%
5 0.80 0.20 4.00 D 15.0% 7.50% 3.60 26.60% 11.32%

Struktur kapital dengan WACC paling rendah 10.64% adalah pada skenario 4 dengan 60% debt
dan 40% equity, dengan demikian pada saat kenaikan pajak menjadi 50% PT. TUNDRA JAYA
harus membuat proporsi hutang (debt) lebih banyak dari proporsi modal (equity).

11. Soal Kuis Terakhir 2. PT. Bowling Entertaintment menyajikan summary laporan laba rugi (income
statement) untuk periode yang berakhir pada 2017 (dalam jutaan rupiah) seperti dibawah ini ;

Penjualan 25.200
Biaya Operasi (21.900)
Laba sebelum bunga dan pajak 3.300
Biaya Bunga (300)
Laba sebelum pajak 3.000
Pajak (25%) (750)
Laba bersih 2.250

Informasi tambahan : jumlah lembar saham biasa yang beredar adalah 500.000 lembar saham
dengan harga pasar saham adalah Rp 52.500 per lembar sahamnya. Berdasarkan informasi tersebut.
Anda diminta untuk :
a. Hitunglah dividen perlembar saham untuk tahun 2017 apabila PT. Bowling Entertaintment
menetapkan bahwa dividend payout ratio adalah 30% !
b. Hitunglah besarnya dividend yield tahun 2017 !
c. Apabila tahun 2016 PT. Bowling Entertainment melaporkan laba bersih sebesar Rp 2 Milyar dan
jumlah lembar saham yang beredar adalah 400.000 lembar dengan dividend payout ratio
sebesar 30%. Hitunglah dividen per lembar saham pada tahun 2016 tersebut !

Jawaban ;

a. Total dividend2017 = Net income2017  Payout ratio

= Rp 2.250.000.000  0.30
= Rp 675.000.000

DPS2017 = Dividends2017/Shares outstanding

= Rp 675.000.000/500,000
= Rp 1.350 per lembar

b. Dividend yield = DPS/P0

= Rp 1.350/ Rp 52.500
= 2.57%.

c. Total dividend2016 = Net income2016  Payout ratio

= Rp 2.000.000.000  0.3
= Rp 600.000.000

DPS2016 = Dividends2016/Shares outstanding

= Rp 600.000.000/500,000
= Rp 1.200 per lembar.