Reference no: EM132194135
Part I Short Answer/Discussion
1. Why is there a cost for reinvested (retained) earnings?
2. What are the three ways to determine the cost of equity?
3. If you use book value weights to compute a firm's weighted average cost of capital (WACC), would the WACC be lower or higher than one computed using market value weights? Explain your answer.
4. List and briefly explain the four mistakes to avoid when computing a firm's WACC.
5. Under what conditions would a project have more than one IRR? How would you reconcile this problem?
6. Explain why there could be a conflict between the IRR and NPV of a project?
7. When calculating the cash flow of a project, should you subtract the cost of financing the project? Why or why not?
8. List and briefly explain the three types of risk that are relevant for capital budgeting.
9. Why is it important to consider real options in capital budgeting? What are some types of real options?
10. List and briefly explain the primary types of leases.
11. List and briefly explain the common methods of estimating growth rates.
Part II Show all work.
1. A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $7.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the issue price. What is the firm's cost of preferred stock?
2. Kelley, Inc. has the following data: rRF = 3.00%; RPM = 5.50%; and b = 1.05. What is the firm's cost of common equity from reinvested earnings based on the CAPM?
3. As a consultant to Saban, Inc., you have been provided with the following data: D1 = $0.50; P0 = $30.00; and g = 7.00% (constant). What is the cost of common equty from reinvested earnings based on the DCF approach?
4. Dabo Company's target capital structure is 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 5.00%, the cost of preferred is 7.50%, and the cost of common using reinvested earnings is 12.00%. The firm will not be issuing any new stock. You were hired as a consultant to help determine its cost of capital. What is its WACC?
5. Harris Electric Company's noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 21%, what is the component cost of debt for use in the WACC calculation?
6. Tua Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current year; its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. New stock can be sold to the public at the current price, but a flotation cost of 3% would be incurred. What would be the cost of equity from new common stock?
7. Murray, Co. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.
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WACC:
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12.00%
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Year
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0
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1
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2
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3
|
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Cash flows
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-$950
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$500
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$400
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$300
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8. Haskins Electronics is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC (and even negative), in which case it will be rejected.
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Year
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0
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1
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2
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3
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Cash flows
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-$1,100
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$450
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$470
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$490
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9. Jeudy's Computer Consultants Inc. is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's MIRR can be less than the WACC (and even negative), in which case it will be rejected.
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WACC:
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9.00%
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|
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Year
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0
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1
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2
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3
|
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Cash flows
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-$1,000
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$450
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$450
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$450
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10. Waddle's Car Wash Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?
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WACC:
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8.00%
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|
|
|
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Year
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0
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1
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2
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3
|
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Cash flows
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-$900
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$500
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$500
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$500
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11. Cochran Inc., the company you work for, is considering a new project whose data are shown below. What is the project's Year 1 cash flow?
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Sales revenues, each year
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$62,500
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Depreciation
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$8,000
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Other operating costs
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$30,000
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Interest expense
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$6,000
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Tax rate
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21.0%
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12. McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?
13. Locksley Film Co. is selling off some old equipment it no longer needs because its associated project has come to an end. The equipment originally cost $22,500, of which 55% has been depreciated. The firm can sell the used equipment today for $5,000, and its tax rate is 21%. What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale.
14. Meyer Retirement (Again) Company (MTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $80,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 8%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time.
The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $25,000. If MTC buys the truck, it would purchase a maintenance contract that costs $1,500 per year, payable at the beginning of each year.
The lease terms, which include maintenance, call for a $19,000 lease payment (4 payments total) at the beginning of each year. MTC's tax rate is 21%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07 respectively and round all dollar to the nearest whole number.)