# What is Internal Capital and how should it be priced when computing WACC?

December 9, 2020
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December 9, 2020

What is Internal Capital and how should it be priced when computing WACC?

1. List some of the factors which make debt less expensive than equity.
2. Explain the tax-effect upon the cost of debt.
3. Why might a hotel project have a higher interest rate than a single-family home loan?
4. What is Internal Capital and how should it be priced when computing WACC?
5. What is the Yield Curve and what can it tell you about the stock market’s prospects?
Chapter 6 – Equity Partner Return
Listed below is an example of the Return on Equity calculation for a \$300,000 project with \$210,000 of debt @ 10% and \$90,000 of equity @ 30% of net cash flow. The
cash flow is \$81,000.
6. Calculate the Return on Equity for an equity partner who receives 35% of the net cash flow of a \$1,500,000 project with 70% of debt @ 12%. The projected cash flow
is \$560,000.
7. Calculate the Return on Equity for an equity partner who receives 25% of the net cash flow of a \$1,200,000 project with 60% of debt @ 9%. The projected cash flow is
\$420,000.
Chapter 6 – WACC (Known ROE)
Listed below is an example of a Weighted Average Cost of Capital (WACC) calculation for a \$200,000 project financed by \$120,000 of debt @ 12% and \$80,000 of
equity at 25%. The tax rate is 33%.
\$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt \$1,20,000 60.0% 12.0% 33.0% 8.0% 4.8%
Equity \$80,000 40.0% 25.0% 33.0% 25.0% 10.0%
Total \$2,00,000 100.0% 14.8%
8. Calculate the WACC for a \$450,000 project, 70% financed by debt @ 9% and the balance by equity at 19%. The tax rate is 28%.
\$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
9. Calculate the WACC for a \$1,600,000 project, 65% financed by debt @ 13% and the balance by equity at 24%. The tax rate is 31%.
\$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
Chapter 6 – WACC (ROE from Share of Cash Flow)
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HOS 470 Chapter 6 Homework – List some of the factors which make debt less expensive than
equity.
Dated: 30th Nov’15 11:48 AM
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10/9/2017 HOS 470 Chapter 6 Homework – List some of the factors which make debt less expensive than equity. – SKU 105311
10. Calculate the Return on Equity for an equity partner who receives 27% of the net cash flow of a \$2,200,000 project with 65% of debt @ 11%. The projected cash flow
is \$620,000. The tax rate is 32%
Item Calculation Result
Project Cash Flow Project Cash Flow
Interest Cost Interest Cost
Net Cash Flow Net Cash Flow
Equity Partner Share Equity Partner \$ Share
Cost of Equity Return on Equity
11. Now calculate the WACC for that project.
\$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
Chapter 6: Conversion of Historic Bank to Hotel (pg 175)
The Williams Bennett Hotel Development Co. has identified an historic bank building that could be converted into a hotel. The location is in the heart of downtown
Smithton, a densely populated city. The structure was designed by an acclaimed architect and built in 1913. The fifteen-story will be transformed into a chic boutique
hotel with the hotel lobby, meeting rooms, cafe and fitness area on the first two floors. The remaining thirteen floors will contain 130 guest rooms. The entire project will
cost \$35,000,000. 60% of the project will be financed with debt and \$14 million is being provided by equity investors. The lender is offering a loan at a 12% interest rate
and the equity investors are requiring a return of 18% on their investment. The current business tax rate is 25%. Because the structure is an historic landmark, the
development company has been in discussions with government agencies to determine if there are any public incentives for redeveloping the property. The hotel market
in Smithton is underserved and the city needs additional rooms to attract larger convention groups. The city would also gain additional jobs which would lower the
unemployment rate and a spur to the local retail and restaurant market from the new guests.
12. Calculate the WACC for this project:
\$ Weight % PreTax % Cost Tax Rate % AfterTax % Cost Weighted Cost
Debt
Equity
Total
What subsidies can the government offer to the development?
How would a potential real estate tax abatement of \$1,000,000, evenly spread over 5 years, impact the project’s ability to service debt?
Chapter 6: Turner County Luxury Mixed Use Development (pg 175-176)
Frank Douglas, a real estate developer, just finalized a major deal with Turner County to develop a major hotel/luxury condominium/golf/conference center/residential
mixed-use project on land owned by Turner County. The development will include a 150 room five-star hotel, 75 luxury 2,500 sq. ft. condominium units, an eighteen hole
championship golf course and 360 residential golf course lots. The total development cost, exclusive of the cost of the land and financing expenses, is projected to be
\$250,000 per room for the hotel, \$200 per square foot for the luxury condominium units, \$6 million for the golf course and 10% of the projected \$500,000 selling price for
each residential lot. The county has agreed to contribute the land to the project at no cost. The county’s justification for this contribution is the new jobs, real estate taxes
and new visitors to the area generated by the mixed-use development.
Summary of the Project Data:
Hotel rooms 150
Cost per room \$2,50,000
Condo units 75
Condo size (square feet) 2,500
Condo cost per square foot \$200
Golf course \$60,00,000
Residential lots 360
Selling price per residential lot \$5,00,000
Residential lot development cost (% of selling price) 10%
A. Calculate the Project Costs using the above data:
Hotel
75 Condominiums
360 Residential Lots
Golf Course
10/9/2017 HOS 470 Chapter 6 Homework – List some of the factors which make debt less expensive than equity. – SKU 105311