21 May WHICH OF THE FOLLOWING EVENTS WOULD REDUCE ITS WACC?
Each question is worth
2.5 points and your answer must be recorded on the Answer Sheet for you to
receive credit. All answers are
considered right or wrong; no partial credit will be given. Please answer dollar questions to the nearest
cent, like $1,234.56, and rate of return or percentage questions to two decimal
places, like 12.34% or 0.1234 in decimal form, and number questions like ratios
or beta to two decimal places, like 1.23.
Chapter 7:
1. A stock is expected
to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate
of 5% a year forever (g = -5%). If the
company’s expected and required rate of return is 15%, which of the following
statements is CORRECT?
a. The company’s
current stock price is $20.
b. The company’s
dividend yield 5 years from now is expected to be 10%.
c. The constant growth
model cannot be used because the growth rate is negative.
d. The company’s
expected capital gains yield is 5%.
e. The company’s stock
price next year is expected to be $9.50.
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 3.0%, 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 $45 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 $1.90 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 1.45, 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 4.75%, 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. Suppose Yon Sun
Corporation’s free cash flow during the just-ended (t = 0) year was $150
million, and FCF is expected to grow at a constant rate of 6% in the
future. If the weighted average cost of
capital is 20%, what is the firm’s value of operations, in millions?
9. Zhdanov, Inc.
forecasts that its free cash flow in the coming year, i.e., at t = 1, will be
-$15 million (negative), but
its FCF at t = 2 will be $30 million.
After Year 2, FCF is expected to grow at a constant rate of 4%
forever. If the weighted average cost of
capital is 15%, what is the firm’s value of operations, in millions?
10. Vasudevan, Inc.
forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 15%
and the free cash flows are expected to continue growing at the same rate after
Year 3 as from Year 2 to Year 3,
what is the Year 0 value of operations, in millions?
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Chapter 9:
11. Schalheim Sisters
Inc. has always paid out all of its earnings as dividends, and hence has no
retained earnings. This same situation is expected to persist in the
future. The company uses the CAPM to
calculate its cost of equity. Its target
capital structure consists of common stock, preferred stock, and debt. Which of the following events would reduce its
WACC?
a. The market risk premium declines.
b. The flotation costs associated with
issuing new common stock increase.
c. The company’s beta increases.
d. Expected inflation increases.
e. The flotation costs associated with
issuing preferred stock increase.
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 5.00% 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 1.15. 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 = $1.70; 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 5.00% 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 $25 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 38%. 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 9% 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 14.75%, 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 14.00%; 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?
Chapter 10:
21. Projects C and D are
mutually exclusive and have normal cash flows with an initial outflow followed
by a series of positive cash inflows. Project C has a higher NPV if the WACC is
less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?
a. Project D has a higher IRR.
b. Project D is probably larger in scale
than Project C.
c. Project C probably has a faster
payback.
d. Project C has a higher IRR.
e. The crossover rate between the two
projects is below 12%.
| 22. Frye Foods is considering a project that has the following cash flow data. What is theproject’s IRR? |
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