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# Finance: Assume that Microsoft’s optimal debt ratio is 40%

Question
Exercise

The first part of this assignment asks you to estimate the weighted average cost of capital (WACC) for Microsoft Corporation.

Assume that Microsoft’s optimal debt ratio is 40%, tax rate is 30% and its cost of debt is 6%.

To compute the required rate of return on equity, go to Yahoo Finance website https://finance.yahoo.com/. Look for Microsoft Corporation data (just search for it either typing the full name or using the symbol of the company MSFT). Once you are on the Microsoft page click on historical data. The time period has to be of 5 years and the frequency is monthly. Secondly, you need to download the data for the market portfolio. Use the S&P 500 index. For both Microsoft and the S&P 500 use the adjusted prices (adj price column when downloading from Yahoo Finance).

In your calculation of the required rate of return using the CAPM formula, assume the riskfree rate to be 3%.

Once you have all the data, you have to:

1) Compute the Beta of Microsoft. What is its interpretation? 2) Plot the trendline (Characteristic line) 3) Compute the return on the market portfolio. Hint: you need to convert the

monthly returns we are using in yearly return by multiplying the monthly returns x 12. 4) Compute the required rate of return. 5) Compute the WACC.

Microsoft Corporation just constructed a manufacturing plant in Ghana. The construction cost 10 billion Ghanian cedi. Microsoft intends to leave the plant open for three years. During the three years of operation, after-tax cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. Operating cash flows will begin one year from today and are remitted back to the parent at the end of each year. At the end of the third year, Microsoft expects to sell the plant for 5 billion cedi. Microsoft has a required rate of return that you just computed. It currently takes 8,700 cedi to buy one U.S. dollar, and the cedi is expected to depreciate by 5 percent per year.

6) Determine the NPV of the project. Should Microsoft build the plant?

7) Determine the APV of the project considering an all-equity required rate of return for Microsoft of 10%. Would the decision of Microsoft change?

Suppose now that the Ghanian Government has promised to arrange for a substantial portion of the construction cost to be financed at an attractive concessionary interest rate if the plant is built there. The conditions offered are the following: a) Microsoft is allowed to borrow 7.5 billion Ghanian cedi at a rate of 4% per year b) The loan schedule for the principal is to be repaid in 3 equal instalments.

8) What is the percentage of the concessionary loan that Microsoft should shield? 9) How is the APV now?

Let’s go back to the situation you used to answer question 6 above (i.e., no concessionary

loan). As we said above, Microsoft plans to repatriate 100% of the cedi cash flows each year. Assume that the cedi cash flows are pre-tax now. Therefore, the pre-tax cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. You also know that the Ghanian tax rate is 25%, and that US tax authorities will give full credit for taxes paid in Ghana. Hint for the solution: Go back to the case where there is no debt. Do the analysis in Ghanian cedi first, so you apply the Ghanian tax rate to the cash flows. Then you need to repatriate the after-tax cash flows in the US (remember to transform them in USD) and follow the tax credit table we went through in class.

10) Compute the NPV in USD under this scenario.

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