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The X Corporation has an opportunity to sell widgets. The CEO would like for the vice president to evaluate the possibility of producing widgets. The marketing manager believes that they can sell 300,000 widgets in the first year; 225,000 in the second year and 200,000 units in the third year. The price for widgets is expected to be $2.00 per widget. The plant manager believes the equipment will cost $500,000 with shipping and installation being another $150,000. He/she believes the cost will be $0.85 per unit or 42.5% of sales plus a fixed cost of $47,500. He/she estimates inventory will be increased by $80,000. He/she believes after the three-year run of widgets, the equipment will be worth $325,000. The CFO says the equipment will fall under the 3-years MACRS schedule. He/she believes accounts payable will decrease by $50,000 and accounts receivable will increase by $100,000. He/she tells the vice president that the corporate tax rate is a flat 34%. The required return on a project of this type should be 13%. The X Corporation has 200,000 shares of stock outstanding. Their stock sells for $25 per share. They have 2,500 outstanding bonds. The bonds current price is $1000. They just paid $2 a share in dividends. They are expected to grow at 6%. The market is expected to return 10%. Treasury bonds yield 5%. They have a beta of 1.9. Their bonds sell for $1200. The coupon rate is 8%. Par is $1000. They pay semi-annual payments. The bonds mature in 10 years. Floatation cost are $5 per share. Retained earnings are $700,000.

MACRS

Year 1 33%

Year 2 45%

Year 3 15%

Year 4 7%

  1. What is the cost of debt?
  1. What is the weight of debt?
  1. What is the cost of equity using SML equation?
  1. What is the cost of equity using constant growth model for retained earnings?
  1. What is the cost of equity using constant growth model for new equity?
  1. What is the weight of equity?
  1. What is the weighted average cost of capital for retained earnings?
  1. What is the weighted average cost of capital for new equity?
  2. What is the break point for retained earnings?

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