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

| September 28, 2018

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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