The Laundromat Corporation is considering opening another coin-operated laundry in a city. It has estimated that opening the laundry would involve an initial cost of $100,000 and would generate a net cash flow of $32,000 in each of the following five years, with no salvage value for the equipment and no recovery of operating expenses at the end of the five years. The corporation estimates that it would have to pay a rate of 12% on its bonds and that it would face a marginal income tax rate of 40%. The interest on government securities is 10%. During the current year, the corporation expects to pay a dividend of $20 on each share of its common stock, which sells for 10 times current earnings. Management and outside analysts expects the growth rate of earnings and dividends of the corporation to be 7% per year. The return on the average stock of all firms in the market is 14%, and the estimated beta coefficient () for the common stock of the corporation is 1.25. The corporation wants to maintain a capital structure of 30% debt. Determine: (A)The IRR for the proposed project, (B) The cost of debt for the corporation (kd), (C)The cost of equity capital by the risk-free rate plus premium method (ke), (D)The cost of equity capital by the dividend valuation model (ke), (E) The cost of equity capital by the capital asset pricing model (CAPM) (ke), (F) The weighted average cost of capital if the firm uses the average cost of equity capital determined by each of the three methods mentioned in C, D and E above,
Q1. The Laundromat Corporation is considering opening another coin-operated laundry in a city. It has estimated that opening the laundry would involve an initial cost of $100,000 and would generate a net cash flow of $32,000 in each of the following five years, with no salvage value for the equipment and no recovery of operating expenses at the end of the five years. The corporation estimates that it would have to pay a rate of 12% on its bonds and that it would face a marginal income tax rate of 40%. The interest on government securities is 10%. During the current year, the corporation expects to pay a dividend of $20 on each share of its common stock, which sells for 10 times current earnings. Management and outside analysts expects the growth rate of earnings and dividends of the corporation to be 7% per year. The return on the average stock of all firms in the market is 14%, and the estimated beta coefficient () for the common stock of the corporation is 1.25. The corporation wants to maintain a capital structure of 30% debt. Determine:
(A)The
(B) The cost of debt for the corporation (kd),
(C)The
(D)The cost of equity capital by the dividend valuation model (ke),
(E) The cost of equity capital by the
(F) The weighted average cost of capital if the firm uses the average cost of equity capital determined by each of the three methods mentioned in C, D and E above,
(G)Whether or not the corporation should undertake the project.
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