Financial Planning Problems

| August 14, 2017

Choice: Problems

(The following information applies to the next four
problems. Financial calculator

You are employed by CGT, a Fortune 500 firm that is a major
producer of chemicals and plastic goods:
plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an
assistant to the Vice-President of Finance.
This is a position with high visibility and the opportunity for rapid
advancement, providing you make the right decisions. Your boss has asked you to estimate the
weighted average cost of capital for the company. Following are balance sheets and some
information about CGT.

Current assets $38,000,000
Net plant,
property, and equipment $101,000,000

Assets $139,000,000

and Equity
Accounts payable $10,000,000
Accruals $9,000,000
Current liabilities $19,000,000

Long term debt
(40,000 bonds, $1,000 face value) $40,000,000
Total liabilities $59,000,000

Common Stock
10,000,000 shares) $30,000,000
Retained Earnings $50,000,000
Total shareholders
equity $80,000,000

liabilities and shareholders equity $139,000,000

You check The Wall Street Journal and see that CGT stock
is currently selling for $7.50 per share and that CGT bonds are selling for
$889.50 per bond. These bonds have a
7.25 percent annual coupon rate, with semi-annual payments. The bonds mature in twenty years. The beta for your company is approximately
equal to 1.1. The yield on a 6-month
Treasury bill is 3.5 percent and the yield on a 20-year Treasury bond is 5.5
percent. The expected return on the
stock market is 11.5 percent, but the stock market has had an average annual
return of 14.5 percent during the past five years. CGT is in the 40 percent tax bracket.

.doc#_edn1″ title=””>[1]. Using
the CAPM approach, what is the best estimate of the cost of equity for CGT?

a. 10.10%
b. 12.10%
c. 12.30%
d. 15.40%
e. 15.60%

.doc#_edn2″ title=””>[2]. What is best estimate for the after-tax cost
of debt for CGT?

a. 2.52%
b. 4.20%
c. 4.35%
d. 5.04%
e. 5.37%

.doc#_edn3″ title=””>[3]. Which of the following is the best estimate
for the weights to be used when calculating the WACCC?

a. we = 57.6% and wd = 42.4%
b. we = 65.2% and wd = 34.8%
c. we = 66.7% and wd = 33.3%
d. we = 67.8% and wd = 32.2%
e. we = 72.4% and wd = 27.6%

.doc#_edn4″ title=””>[4]. What is the best estimate of the WACC for

a. 8.65%
b. 8.92%
c. 9.18%
d. 9.75%
e. 9.83%

.doc#_edn5″ title=””>[5]. Hamilton
Company’s 8 percent coupon rate, quarterly payment, $1,000 par value bond,
which matures in 20 years, currently sells at a price of $686.86. The company’s tax rate is 40 percent. Based on the nominal interest rate, not the
EAR, what is the firm’s component cost of debt for purposes of calculating the

d. 12.20%
e. 12.26%

.doc#_edn6″ title=””>[6]. A
stock analyst has obtained the following information about J-Mart, a large
retail chain:
(1) The company has noncallable bonds with
20 years maturity remaining and a maturity value of $1,000. The bonds have a 12 percent annual coupon and
currently sell at a price of $1,273.8564.
(2) Over
the past four years, the returns on the market and on J-Mart were as follows:

Year Market J-Mart
12.0% 14.5%
17.2 22.2
-3.8 -7.5
20.0 24.0

(3) The
current risk-free rate is 6.35 percent, and the expected return on the market
is 11.35 percent. The company’s tax rate
is 35 percent.

The company anticipates that its proposed
investment projects will be financed with 70 percent debt and 30 percent
equity. What is the company’s estimated
weighted average cost of capital (WACC)?

c. 10.25%
d. 12.33%
e. 13.14%


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