Percentages need to be entered in decimal format, for instance 3% would be entered as .03. Ezzell Enterprises has the following capital structure, which it considers to be optimal under present and forecasted conditions: Debt (long-term only) ratio - 45% Common equity - 55% Total liabilities and equity - 100% For the coming year, management expects after-tax earning of $2.5 million. Ezzell's past dividend policy of paying out 60% of earnings will continue. Present commitments from its bankers will allow Ezzell to borrow according to the following schedule: Loan Amount Interest Rate $1 to $500,000 9% on this increment of debt $500,001 to $900,000 11% on this increment of debt $900,001 and above 13% on this increment of debt The company's marginal tax rate is 40%, the current market price of its stock is $22 per share, its last dividend was $2.20 per share, and the expected growth rate is 5%. External equity (new common) can be sold at a flotation cost of 10%. Project Cost Annual cash flows Project life Expected return 1 $675,000 $155,401 8 years 16% 2 $900,000 $268,484 5 years 15% 3 $375,000 $161,524 3 years 14% 4 $562,500 $185,194 4 years 12% 5 $750,000 $127,351 10 years 11% Management asks you to help determine which projects (if any) should be undertaken. You proceed with this analysis by answering the following questions (or performing the tasks) as posed. (This information is shown on the spreadsheet provided.) How many breaks are there in the MCC schedule? At what dollar amounts do the breaks occur, and what causes them - debt or retained earnings? (Refer to Rows 44 -48 on the worksheet.) What is the weighted average cost of capital (WACC) in each of the intervals between the breaks? (Refer to the Key Output area in Columns D-F at the top of the worksheet.) Which projects should Ezzell's management accept? (Refer to the Optimal Capital Budget beginning on Row 93 to see which projects are listed, meaning they should be accepted.) The problem stated that Ezzell pays out 60% of its earnings as dividends. Which project(s) should management accept if the dividend payout ratio were changed to 0%? Which project(s) should management accept if the dividend payout ratio were changed to 100%? (Refer again to the Optimal Capital Budget beginning on row 93.) Now assume the dividend payout ration is back to 60%, but the debt ratio has increased to 65%. This caused all interest rates rd (Column C, Rows 29-31) to rise by one percentage point to 10%, 12%, and 14% respectively, and the growth rate to increase from 5% to 6%. Examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.) Assume the same figures as in Question 4, but suppose Ezzell's marginal tax rate (Column C, Row 20) falls to 20%. Examine what happens to the MCC schedule and identify which project(s) management should accept. Suppose the marginal tax rate falls to 0%, examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.)

Percentages need to be entered in decimal format, for instance 3% would be entered as .03. Ezzell Enterprises has the following capital structure, which it considers to be optimal under present and forecasted conditions: Debt (long-term only) ratio - 45% Common equity - 55% Total liabilities and equity - 100% For the coming year, management expects after-tax earning of $2.5 million. Ezzell's past dividend policy of paying out 60% of earnings will continue. Present commitments from its bankers will allow Ezzell to borrow according to the following schedule: Loan Amount Interest Rate $1 to $500,000 9% on this increment of debt $500,001 to $900,000 11% on this increment of debt $900,001 and above 13% on this increment of debt The company's marginal tax rate is 40%, the current market price of its stock is $22 per share, its last dividend was $2.20 per share, and the expected growth rate is 5%. External equity (new common) can be sold at a flotation cost of 10%. Project Cost Annual cash flows Project life Expected return 1 $675,000 $155,401 8 years 16% 2 $900,000 $268,484 5 years 15% 3 $375,000 $161,524 3 years 14% 4 $562,500 $185,194 4 years 12% 5 $750,000 $127,351 10 years 11% Management asks you to help determine which projects (if any) should be undertaken. You proceed with this analysis by answering the following questions (or performing the tasks) as posed. (This information is shown on the spreadsheet provided.) How many breaks are there in the MCC schedule? At what dollar amounts do the breaks occur, and what causes them - debt or retained earnings? (Refer to Rows 44 -48 on the worksheet.) What is the weighted average cost of capital (WACC) in each of the intervals between the breaks? (Refer to the Key Output area in Columns D-F at the top of the worksheet.) Which projects should Ezzell's management accept? (Refer to the Optimal Capital Budget beginning on Row 93 to see which projects are listed, meaning they should be accepted.) The problem stated that Ezzell pays out 60% of its earnings as dividends. Which project(s) should management accept if the dividend payout ratio were changed to 0%? Which project(s) should management accept if the dividend payout ratio were changed to 100%? (Refer again to the Optimal Capital Budget beginning on row 93.) Now assume the dividend payout ration is back to 60%, but the debt ratio has increased to 65%. This caused all interest rates rd (Column C, Rows 29-31) to rise by one percentage point to 10%, 12%, and 14% respectively, and the growth rate to increase from 5% to 6%. Examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.) Assume the same figures as in Question 4, but suppose Ezzell's marginal tax rate (Column C, Row 20) falls to 20%. Examine what happens to the MCC schedule and identify which project(s) management should accept. Suppose the marginal tax rate falls to 0%, examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.)

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Percentages need to be entered in decimal format, for instance 3% would be entered as .03.

Ezzell Enterprises has the following capital structure, which it considers to be optimal under present and forecasted conditions:

Debt (long-term only) ratio - 45%
Common equity - 55%
Total liabilities and equity - 100%

For the coming year, management expects after-tax earning of $2.5 million. Ezzell's past dividend policy of paying out 60% of earnings will continue. Present commitments from its bankers will allow Ezzell to borrow according to the following schedule:

Loan Amount	Interest Rate
$1 to $500,000	9% on this increment of debt
$500,001 to $900,000	11% on this increment of debt
$900,001 and above	13% on this increment of debt

The company's marginal tax rate is 40%, the current market price of its stock is $22 per share, its last dividend was $2.20 per share, and the expected growth rate is 5%. External equity (new common) can be sold at a flotation cost of 10%.

Project	Cost	Annual cash flows	Project life	Expected return
1	$675,000	$155,401	8 years	16%
2	$900,000	$268,484	5 years	15%
3	$375,000	$161,524	3 years	14%
4	$562,500	$185,194	4 years	12%
5	$750,000	$127,351	10 years	11%

Management asks you to help determine which projects (if any) should be undertaken. You proceed with this analysis by answering the following questions (or performing the tasks) as posed. (This information is shown on the spreadsheet provided.)

How many breaks are there in the MCC schedule? At what dollar amounts do the breaks occur, and what causes them - debt or retained earnings? (Refer to Rows 44 -48 on the worksheet.) What is the weighted average cost of capital (WACC) in each of the intervals between the breaks? (Refer to the Key Output area in Columns D-F at the top of the worksheet.)
Which projects should Ezzell's management accept? (Refer to the Optimal Capital Budget beginning on Row 93 to see which projects are listed, meaning they should be accepted.)
The problem stated that Ezzell pays out 60% of its earnings as dividends. Which project(s) should management accept if the dividend payout ratio were changed to 0%? Which project(s) should management accept if the dividend payout ratio were changed to 100%? (Refer again to the Optimal Capital Budget beginning on row 93.)
Now assume the dividend payout ration is back to 60%, but the debt ratio has increased to 65%. This caused all interest rates r_d (Column C, Rows 29-31) to rise by one percentage point to 10%, 12%, and 14% respectively, and the growth rate to increase from 5% to 6%. Examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.)
Assume the same figures as in Question 4, but suppose Ezzell's marginal tax rate (Column C, Row 20) falls to 20%. Examine what happens to the MCC schedule and identify which project(s) management should accept. Suppose the marginal tax rate falls to 0%, examine what happens to the MCC schedule and identify which project(s) management should accept. (Refer again to the Optimal Capital Budget section.)

to select the opumal capital buaget. we nave alreaay entered the base-case data
3. The model assumes that if a project's return is less than the cost of capital, the project is
rejected. No allowance is made for situations where the MCC cuts through a project on the IOS.
In other words, the projects are not divisible.
4. When you go on to work other parts of the problem, the easiest way to proceed is to make
the required changes in the input section, observe the change to each of the four weighted
average costs of capital, record the change, and answer the question as required.
INPUT DATA:
KEY OUTPUT:
Debt ratio:
Earnings:
Dividend payout rati
45.00% Ret. earnings break
$2,500,000 1st debt break
1,818,182
1,111,111
2,000,000
60.00% 2nd debt break
Таx rate:
40.00%
Current Stock Price
$22.00 WACC before break 1
11.2%
Last dividend paid ([
$2.20 WACC before break 2
11.5%
Growth rate:
5.00% WACC before break 3
12.1%
Equity flotation cost:
10.00% WACC after break 3
13.2%
Beginning of
Range
Аcсepted
Projects
(non-zero)
Project
Cost
New debt cost:
rd
IRR
10.00%
$675,000
$900,000
1
1
16%
500,001
900,001
11.00%
2
15%
15.00%
$375,000
$0
3
14%
0%
Project
Number/rank
Cost
IRR
0%
$0
$1,950,000
675,000
900,000
375,000
1
16.00%
Capital budget =
2
15.00%
14.00%
4
562,500
750,000
12.00%
11.00%
MODEL-GENERATED DATA:
Breaks in the MCC schedule:
Use of retained earnings
Use of debt at:
Use of debt at:
1,818,182
1,111,111
2,000,000
10%
11%
Cost of financing below first break:
After-tax
Weighted
Component
Weight
Cost
Cost
6.00%
15.50%
Debt
0.45
2.70%
Equity
0.55
8.53%
WACC 1 =
11.23%
Cost of financing between first and second breaks:
After-tax
Weighted
Cost
Component
Weight
Cost
Debt
0.45
6.60%
2.97%
8.53%
11.50%
Equity
0.55
15.50%
WACC 2 =
Cost of financing between second and third breaks:
Weighted
Cost
After-tax
Component
Weight
Cost
Debt
0.45
6.60%
2.97%
Equity
0.55
16.67%
9.17%
WACC 3 =
12.14%
Cost of financing above third break:
After-tax
Weighted
Cost
Component
Weight
Cost
Debt
0.45
9.00%
4.05%
Equity
9.17%
13.22%
0.55
16.67%
WACC 4 =
Capital Cost:
Capital cost
11.2%
Range of financing
1
1,111,111
11.2%
1,111,112
11.5%
1,818,182
1,818,183
2,000,000
2,000,001
5,000,000
11.5%
12.1%
12.1%
13.2%
13.2%
Optimal capital budget:
Project
Project
Number/rank
IRR
Cost
16%
675,000
900,000
375,000
1
2
15%
3
14%
0%
0%
1,950,000

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