Atlas Metals Company thinks to change its capital budgeting decision criteria. Currently it looks primarily at Return on Investment of individual projects and accepts the projects that have above average ROI. However, ROI can be easily manipulated because its formula is not well defined and each division of the company can come up with different return on investment using different calculations. On the other hand, this method discourages the proposal of some important projects with low returns. Furthermore, the existing procedure also evaluates prospective projects looking at their payback periods when funds are limited. But we think that this approach is not adequate either because payback rule ignores risk consideration and time value of money and as a result leads to wrong decisions. The optimal budgeting should be based on some techniques that take into account the time value of money and evaluate projects according to their added value to shareholders’ equity. So as a team we have analyzed the projects based on their IRR s and defined the decision criterion being to accept projects if their internal rate of return is larger than weighted average cost of capital.
In this situation we face a problem about calculating WACC (weighted average cost of capital). Correct estimation of WACC is very important because it will affect the company’s ultimate decision about acceptability of the projects.
Where Ks are required rates of returns for short term and long term debt, common equity and preferred equity and Ws are the respective weights of each funding alternative and T is corporate tax rate which is 40%.
_Bo= Coupon payment * PVIFA9%,10 + Par value * PVIF__9%,10_
Bo= 80 * 6.41765 + 1000 * 0.4224 = 935.8234
Number of Bonds = 121,326,000/ 1000 = 121,326
Market value of Long term debt= 121,326 * 935.82 = 113,539,713
So, total market value of capital is equal to $ 389.699.713. And weights are as follows;
Now, we should...