Helpful Tips: The text book is Corporate Finance, 8th Edition by
Ross, Westerfield, Jaffe
McKenzie Corporation’s Capital Budgeting
Sam McKenzie is the founder and CEO of Mckenzie Restaurants Inc. ,
a regional company. Sam is considering opening several new
restaurants. Sally Thornton , the company’s CFO, has been put in
charge of the capital budgeting analysis. She has examined the
potential for the company’s expansion and determined that the
success of the new restaurants will depend critically on the state
of the economy over the next few years.
McKenzie currently has a bond issue outstanding with a face value
of $25 million that is due in one year. Covenants associated with
this bond issue prohibit the issuance of any additional debt. This
restriction means that the expansion will be entirely financed with
equity at a cost of $9 million. Sally has summarized her analysis
in the following table, which shows the value of the company in
each state of the economy next year, both with and without
Low .30 $20,000,000
What is the expected value of the company’s debt in one year, with
and without expansion?
One year from now, how much value creation is expected from the
expansion? How much value is expected for stockholders?
Submit answers, as an attachment, to the following
questions. All calculations must be shown. For problems that have
an Excel template, be sure to download the template from the
publisher’s web site, and save as an Excel file. Please use excel
for all work and show calculations as well.
Chapter 14: Problem 1 (NO template is available) – you must use
Excel for this problem
Equity Accounts – Following are the equity accounts for Kerch
Common stock, $0.50 par
Chapter 15: Problem 12 (template is available)
Calculating WACC – Weston Industries has a debt-equity ratio of
1.5. Its WACC is 12 percent, and its cost of debt is 12 percent.
The corporate tax rate is 35 percent.
a. What is Weston’s cost of equity capital?
b. What is Weston’s unlevered cost of equity capital?
c. What would the cost of equity be if the debt-equity ratio were
2? What if it were 1.0? What if it were zero?
Chapter 16: Problems 1 and 3 (templates are available for both
Firm Value – Janetta Corp. has an EBIT rate of $750,000 per year
that is expected to continue in perpetuity. The unlevered cost of
equity for the company is 15 percent, and the corporate tax rate is
35 percent. The company also has a perpetual bond issue outstanding
with a market value of $1.5 million.
a. What is the value of the company?
b. The CFO of the company informs the company president that the
value of the company is $3.2 million. Is the CFO correct?
Capital Structure and Growth – Edwards Construction currently has
debt outstanding with a market value of $80,000 and a cost of 12
percent. The company has an EBIT rate of $9,600 that is expected to
continue in perpetuity. Assume there are no taxes.
a. What is the value of the company’s equity? What is the
b. What are the equity value and debt-to-value ratio if the
company’s growth rate is 5 percent?
c. What are the equity value and debt-to-value ratio if the
company’s growth rate is 10 percent?