acct 40 Ques-1.A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00

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. 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 13.00%.
What is the intrinsic value of Wei’s stock?

D0

2.75

D1

2.81875

D2

2.88921875

D3

3.12035625

D1

D2

D3

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?

D0

2.75

D1

2.81875

D2

2.88921875

D3

3.12035625

D4

3.36998475

D5

3.63958353

D6

3.930750212

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?

D3

0.5

D4

0.75

D5

0.9375

D6

0.99375

Dividend

D3

0.75

D4

0.9375

D5

0.99375

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?

Debt

Equity

Total

Market Value

55

170

225

Cost

4.55%

14.00%

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 the
project’s IRR?

Year

Cash Flow

0

-1100

1

325

2

325

3

325

4

325

5

325

23. Van
Auken Inc. is considering a project that has the following cash flows:

Year

Cash Flow

Cummulative Cash Flow

0

-1000

-1000

1

400

-600

2

300

-300

3

700

400

4

400

800

24. Babcock Inc. is considering a project
that has the following cash flow and WACC data.
What is the project’s
NPV?

Year

Cash Flow

0

-950

1

500

2

300

3

400

25.
Garvin Enterprises is considering a project that has the following
cash flow and WACC
data. What is the project’s discounted payback?

Year

Cash Flow

PV Factor

PV

Cummulative Cash Flow

0

-1000

1.0000

-1000

-1000

1

500

0.9009

450.4504505

-549.54955

2

500

0.8116

405.8112166

-143.738333

3

500

0.7312

365.5956907

221.857358

26. Hindelang
Inc. is considering a project that has the following cash flow and WACC data.
What is the project’s MIRR?

Year

Cash Flow

0

-900

1

300

2

320

3

340

4

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 = $500,000

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

Year

Cash Flow

1

750000

2

750000

3

750000

4

1250000

PV

$25,95,771.05

28. Anderson Associates is considering two
mutually exclusive projects that have the following cash
Flows:

Project A

Project B

Year

Cash Flow

Cash Flow

Difference

0

-10000

-8000

-2000

1

3000

7000

-4000

2

2000

3000

-1000

3

6000

1000

5000

4

8000

1000

7000

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?

Year

System A

System B

0

-$1,00,000

-$1,00,000

1

60000

$48,000

2

-$40,000

$48,000

3

60000

-$62,000

4

-$40,000

$52,800

5

60000

$52,800

6

60000

$52,800

System B add maximum value and its NPV is
$19,930.94

30. Using the information from problem 29 on
Walker & Campsey, what is the equivalent annual annuity (EAA) for System
A?

31. When evaluating a new project, firms should
include in the projected cash flows all of the

following EXCEPT:

a. Changes in net operating working capital attributable to the project.

b. Previous expenditures associated
with a market test to determine the feasibility of the project provided those
costs have been expensed for tax purposes.

c. The value of a building owned by the firm that will be used for this
project.

d. A decline in the sales of an existing product provided that decline is
directly attributable to this project.

e. The salvage value of assets used for the project at the end of the
project’s life.

32

c. Project X has more market risk
than Project Y.

33

34

35

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 38.0%

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 $80,000
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 $8,000, and its tax
rate is 35%. What is the equipment’s net after-tax salvage value for use in a
capital budgeting analysis?

Net Book Value = 20000*25% = 5000

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%

Dep

Rate

Dep

1

33.33%

19998

2

44.45%

26670

3

14.81%

8886

4

7.41%

4446

Year

1

2

3

Year

0

1

2

3

NPV

40. A
project’s base case or most likely NPV is $50,000, and assume its probability
of occurrence is60%. Assume the best case scenario NPV is 60% 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.

Case

Probality

NPV

NPV – Mean

Prob*(NPV – Mean)^2

Base Case

60.00%

50000

-3000

5400000

Best Case

20.00%

80000

27000

145800000

Worst Case

20.00%

35000

-18000

64800000

Expected NPV

53000

Variation

216000000

Standard deviation

14696.93846