# A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock i

2. A share of common

stock has just paid a dividend of $2.00.

If the expected long-run growth rate for this stock is 4.0%, and if

investors’ required rate of return is 10.5%, what is the stock’s intrinsic

value?

3. E. M. Roussakis

Inc.’s stock currently sells for $40 per share.

The stock’s dividend is projected to increase at a constant rate of 4%

per year. The required rate of return on

the stock, rs, is 15.50%. What is

Roussakis’ expected price 5 years from now?

4. Carter’s preferred

stock pays a dividend of $1.75 per quarter.

If the price of the stock is $60.00, what is its nominal (not effective)

annual expected rate of return?

5. Schnusenberg

Corporation just paid a dividend of $1.25 per share, and that dividend is

expected to grow at a constant rate of 7.00% per year in the future. The company’s beta is 1.25, the required

return on the market is 10.50%, and the risk-free rate is 4.00%. What is the intrinsic value for

Schnusenberg’s stock?

6. Rentz RVs Inc. (RRV)

is presently enjoying relatively high growth because of a surge in the demand

for recreational vehicles. Management

expects earnings and dividends to grow at a rate of 30% for the next 4 years,

after which high gas prices will probably reduce the growth rate in earnings

and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25.

RRV’s beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is

3.00%. What is the intrinsic value of RRV’s common stock?

7. Using the

information on Rentz RVs Inc. from problem 6, what is the dividend yield

expected for the next year?

8. The Wei Company’s

last paid dividend was $2.75. The

dividend growth rate is expected to be constant at 2.50% for 2 years, after

which dividends are expected to grow at a rate of 8.00% forever. Wei’s required return (rs) is 15.00%. What is the intrinsic value of Wei’s stock?

9. Using the

information on Wei Company from problem 8, what should be the price of Wei’s

stock at the end of Year 5?

10. You are an analyst

studying Beranek Technologies, which was founded 10 years ago. It has been profitable for the last 5 years,

but it has needed all of its earnings to support growth and thus has never paid

a dividend. Management has indicated

that it plans to pay a $0.50 dividend 3 years from today, then to increase it

at a relatively rapid rate for 2 years with 50% dividend growth in year 4 and

25% dividend growth in year 5, and then to increase its dividend at a constant growth

rate of 6.00% per year thereafter.

Assuming a required return of 15.00%, what is your estimate of the intrinsic

value of Beranek’s stock?

12. Hettenhouse Company’s

(HC) perpetual preferred stock sells for $105.50 per share, and it pays a $9.50

annual dividend. If the company were to

sell a new preferred issue, it would incur a flotation cost of 4.00% of the

price paid by investors. HC’s marginal

tax rate is 30%. What is the company’s

cost of preferred stock for use in calculating the WACC?

13. Scanlon Inc.’s CFO

hired you as a consultant to help her estimate the cost of capital. You have been provided with the following

data: the risk–free rate of return is 4.00%;

the market risk premium is 6.00%; and Scanlon’s beta is 0.95. Based on the CAPM approach, what is the cost

of equity from retained earnings?

14. Assume that you are a

consultant to Broske Inc., and you have been provided with the following

data: D1 = $1.80; P0 = $45.50; and g =

7.00% (constant). What is the cost of

equity from retained earnings based on the DCF approach?

15. P. Lange Inc. hired your

consulting firm to help them estimate the cost of equity. The yield on Lange’s bonds is 7.25%, and your

firm’s economists believe that the cost of equity can be estimated using a risk

premium of 3.50% over a firm’s own cost of debt. What is an estimate of Lange’s cost of equity

from retained earnings?

16. In their most recent

fiscal year, XYZ, Inc. had net income of $15 million and total common equity of

$200 million. Also, XYZ, Inc. pays out

40% of its earnings as dividends. Using

the Retention Growth Model, what is your best estimate of XYZ’s expected growth

rate?

17. Several years ago the

Pettijohn Company sold a $1,000 par value, noncallable bond that now has 15

years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $950, and the

company’s tax rate is 35%. To issue new

bonds, Pettijohn would incur 3% flotation costs. What is the component cost of debt for use in

the WACC calculation?

18. LePage Co. expects to

earn $2.50 per share during the current year, its expected dividend payout

ratio is 65%, its expected constant dividend growth rate is 6.0%, and its

common stock currently sells for $22.50 per share. New stock can be sold to the public at the

current price, but a flotation cost of 8% would be incurred. What would be the cost of equity from new

common stock?

19. You were hired as a

consultant to Quigley Company, whose target capital structure is 40% debt, 10%

preferred, and 50% common equity. The

interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the

cost of retained earnings is 12.50%, and the tax rate is 34%. The firm will not be issuing any new

stock. What is Quigley’s WACC?

20. Roxie Epoxy’s balance

sheet shows a total of $50 million long-term debt with a coupon rate of 8.00%

and a yield to maturity of 7.00%. This

debt currently has a market value of $55 million. The balance sheet also shows that that the

company has 20 million shares of common stock, and the book value of the common

equity (common stock plus retained earnings) is $65 million. The current stock price is $8.50 per share;

stockholders’ required return, rs, is 12.00%; and the firm’s tax rate is 35%. Based on market value weights, and assuming

the firm is currently at its target capital structure, what WACC should Roxie

use to evaluate capital budgeting projects?

22. Frye Foods is considering a project

that has the following cash flow data.

What is the

project’s IRR?

Year:

0

1

2

3

4

5

Cash

flows:

-$1,200

$325

$325

$325

$325

$325

23. Van Auken Inc. is considering a project

that has the following cash flows:

Year

Cash Flow

0

-$1,000

1

400

2

300

3

800

4

400

The company’s WACC is 10%. What is the project’s ordinary payback?

24. Babcock Inc. is considering a project

that has the following cash flow and WACC data.

What is the project’s NPV?

WACC:

11.00%

Year:

0

1

2

3

Cash

flows:

-$950

$500

$300

$400

25. Garvin Enterprises is considering a

project that has the following cash flow and WACC

data.

What is the project’s discounted payback?

WACC:

9.00%

Year:

0

1

2

3

Cash

flows:

-$1,000

$500

$500

$500

26. Hindelang Inc. is considering a project

that has the following cash flow and WACC data.

What is the project’s MIRR?

WACC:

15.00%

Year:

0

1

2

3

4

Cash

flows:

-$900

$300

$320

$340

$360

27. Hogwarts

Inc. is considering a project with the following cash flows:

Initial

cash outlay = $2,500,000

After–tax

net operating cash flows for years 1 to 4 = $750,000 per year

Additional

after–tax terminal cash flow at the end of year 4 = $400,000

Compute

the profitability index of this project if Hogwarts’ WACC is 12%.

28.

Anderson Associates is considering two mutually exclusive projects that

have the following cash

flows:

Project A Project B

Year Cash Flow Cash Flow

0 -$10,000 -$8,000

1 1,000 7,000

2 2,000 3,000

3 6,000 1,000

4 8,000 1,000

At what cost of capital do the two projects

have the same net present value? (That is, what is the crossover rate?)

29. Walker & Campsey

wants to invest in a new computer system, and management has narrowed the

choice to Systems A and B.

System A requires an up-front cost of $100,000, after which it

generates positive after-tax cash flows of $60,000 at the end of each of the

next 2 years. The system could be

replaced every 2 years, and the cash inflows and outflows would remain the

same.

System B also requires an up-front cost of $100,000, after which it

would generate positive after-tax cash flows of $48,000 at the end of each of

the next 3 years. System B can be replaced

every 3 years, but each time the system is replaced, both the cash outflows and

cash inflows would increase by 10%.

The company needs a computer system for 6 years, after which the

current owners plan to retire and liquidate the firm. The company’s cost of capital is 14%. What is the NPV (on a 6-year extended basis)

of the system that adds the most value?

30. Using the information

from problem 29 on Walker & Campsey, what is the equivalent annual annuity

(EAA) for System A?

32. Taussig Technologies is considering two

potential projects, X and Y. In

assessing the projects’ risks, the company estimated the beta of each project

versus both the company’s other assets and the stock market, and it also

conducted thorough scenario and simulation analyses. This research produced the following

numbers:

Project X

Project Y

Expected NPV

$350,000

$350,000

Standard deviation (sNPV)

$100,000

$150,000

Project beta (vs. market)

1.4

0.8

Correlation of the project cash flows with cash flows

from currently existing projects.

Cash flows are not correlated with the cash

flows from existing projects.

Cash flows are highlycorrelated with the cash

flows from existing projects.

36. You work for Athens Inc., and you must

estimate the Year 1 operating cash flow for a project with the following

data. What is the Year 1 after-tax net

operating cash flow?

Sales

revenues

$15,000

Depreciation

$4,000

Cash

operating costs

$6,000

Tax

rate

34.0%

37. Fool Proof Software is considering a new

project whose data are shown below.

The equipment that will be used has a 3-year class life, and will be

depreciated by the MACRS depreciation system.

Revenues and Cash operating costs are expected to be constant over the

project’s 10-year life. What is the

Year 1 after-tax net operating cash flow?

Equipment

cost (depreciable basis)

$75,000

Sales

revenues, each year

$60,000

Cash

operating costs

$25,000

Tax

rate

35.0%

38. Bing

Services is now in the final year of a project.

The equipment originally cost $20,000, of which 75% has been

depreciated. Bing can sell the used

equipment today for $6,000, and its tax rate is 35%. What is the equipment’s net after-tax salvage

value for use in a capital budgeting analysis?

39. Thomson Media is considering investing in

some new equipment whose data are shown below. The equipment has a 3-year class life and will

be depreciated by the MACRS depreciation system, and it will have a positive

pre-tax salvage value at the end of Year 3, when the project will be closed

down. Also, some new working capital will

be required, but it will be recovered at the end of the project’s life. Revenues and cash operating costs are

expected to be constant over the project’s 3-year life. What is the project’s NPV?

WACC

12.0%

Net

investment in fixed assets (depreciable basis)

$60,000

Required

new working capital

$10,000

Sales

revenues, each year

$75,000

Operating

costs excl. depr’n, each year

$30,000

Expected

pretax salvage value

$7,000

Tax

rate

35.0%

40. A project’s base case or

most likely NPV is $50,000, and assume its probability of occurrence is

60%. Assume the best case scenario NPV is 40% higher than the base

case and assume the worst

scenario NPV is 30% lower than the base case. Both the best case scenario and the worst

case scenario

have a 20% probability of occurrence. Find the project’s coefficient of variation.

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