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Evaluate stockholder required return
Course:- Financial Management
Reference No.:- EM13479




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Question 1. Hsieh-Hseih Inc. must choose between two copiers: The ZZ20 or the GG50.

The ZZ20 costs $300 and will last for three years.  For tax purposes, it will be depreciated using the straight line method over a 3- year life. The operating expenses for this copier are $185 per year (for three years).

The GG50 costs $400 and will last for five years.  For tax purposes, it will (also) be depreciated using the straight line method over a 3- year life.  The operating expenses for this copier are $200 per year (for five years).

If the appropriate discount rate is 12% and the tax rate is 40%, which copier should be selected?  Why?  Be sure to quantify your answer.

 

Question 2. Adobe Online Company's (stock) beta is 1.40.  The firm's stock-to-total value (S/V) ratio is 0 .7.  The remainder of the firm's capital comes from debt (one currently outstanding bond).  The expected return on the market portfolio is 12%.  The risk-free rate is 4%.  The company's bond has a 7 percent coupon (paid semi-annually), and the bond sells at 110% of par.  The corporate tax rate is 40%.

a) What is Adobe Online's current stockholder required return (Rs)?

b) What is Adobe Online'sweighted average cost of capital?

c) Assume Adobe Online changes its capital structure.  It is now financed entirely with equity (no debt in the capital structure).  What is Adobe Online's new stockholder required return?

 

Question 3. United Pigpen International (UPI) is considering a proposal to manufacture high-protein hog feed.  Just yesterday, Willy Swine (the company president) sent a check in the amount of $45,000 to Ketzenberg Consultants, Inc. (KCI) as payment for a test marketing study.

KCI projects that with a $1.2 million investment in plant at time zero (for tax purposes, the plant should be depreciated over 5 years using the straight line method), UPI will be able to generate time 1 hog feed sales of $4.4 million.  These sales are expected to grow by 8% for the subsequent 3 years.  After year 4, however, demand is projected to drop precipitously.  Consequently the plant will be shut down at t=4 and sold for $800,000.

Manufacturing costs (not including depreciation) are expected to be 90% of sales.  If the project is undertaken, accounts payable (AP) will be $250,000 at t=0.  At t=1, AP will increase to $300,000.  At times 2, and 3 it will stay at $300,000, and at t=4 AP will be reduced to $0.

The project would make use of a vacant grain silo that the company presently owns.  Last week, Hogs Unlimited, a local competitor, offered $700,000 (cash flow after all taxes) to buy the silo.  Although the offer seemed fair and reasonable, UPI decided not to sell.  At time 4, the silo is projected to be worth $800,000 (cash flow after all taxes).

 If the appropriate required return for this type of project is 18% and the corporate tax rate is 40%, should UPI undertake this project?




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