FIN 301 B Porter rachna Exam III - Review I Soln PDF

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Exam III – Review I Soln. 1. Suppose you are an analyst with the following data: rRF = 5.5%; rM - rRF = 6%; b = 0.8; D1 = $1.00; P0 = $25.00; g = 6%; rd = firm’s bond yield = 6.5%. What is this firm’s cost of equity using the CAPM, and DCF methods. CAPM = rRF + b (rM – rRF) CAPM = 5.5 + (0.8) (6) CAPM = 10.3% DCF = rs = (D1/ Po) + g DCF = (1.00/25.00) + .06 DCF = .04 + .06 DCF = 10% 2. A firm has common stock with D1 = $1.50; P0 = $30; g = 5%; and F = 4%. If the firm must issue new stock, what is its cost of issuing new external equity? (10.21%) Re = [D1/Po (1-F)] + g Re = [1.50/ 30 (1-.04)] + 0.05 Re = 10.21% 3. A firm has the following data: Target capital structure of 46 percent debt, 3 percent preferred, and 51 percent common equity; Tax rate = 40%; rd = 7%; rp = 7.5%; and rs = 11.5%. Assume the firm will not be issuing new stock. What is this firm’s WACC? WACC = (wd)(rd)(1 – T) + (wc)(rc) + (wp)(rp) WACC = (.46) (.07) (1-.40) + (.51) (.115) + (.03) (.075) WACC = 0.01932 + 0.05865 + 0.00225 WACC = 0.08022 = 8% 4. Percy Motors has a target capital structure of 40 percent debt and 60 percent equity. The yield to maturity on the company’s outstanding bonds is 9 percent, and the company’s tax rate is 40 percent. Percy’s CFO has calculated the company’s WACC as 9.96 percent. What is the company’s cost of common equity? A. 11% B. 12% C. 13% D. 14% 40% Debt; 60% Common equity; rd = 9%; T = 40%; WACC = 9.96%; rs =? WACC = (wd)(rd)(1 – T) + (wc)(rs) 0.0996 = (0.4)(0.09)(1 – 0.4) + (0.6)rs 0.0996 = 0.0216 + 0.6rs 0.078 = 0.6rs rs = 13%.

5. Hook Industries has a capital structure that consists solely of debt and common equity. The company can issue debt at 11 percent. Its stock currently pays a $2 dividend per share and the stock’s price is currently $24.75. The company’s dividend is expected to grow at a constant rate of 7 percent per year; its tax rate is 35 percent; and the company estimates that its WACC is 13.95 percent. What percentage of the company’s capital structure consists of debt financing? A. 16% B. 18% C. 20% D. 22% rs = D1/P0 + g = $2(1.07)/$24.75 + 7% = 8.65% + 7% = 15.65%. WACC = wd(rd)(1 – T) + wc(rs); wc = 1 – wd. 13.95% = wd(11%)(1 – 0.35) + (1 – wd)(15.65%) 0.1395 = 0.0715wd + 0.1565 – 0.1565wd -0.017 = -0.085wd wd = 0.20 = 20%. 6. Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital is 12 percent. What is the project’s NPV? A. $7,486.68* B. $7,753.78 C. $8,368.46 D. $8,621.88 7. A. B. C. D.

Using the above information, what is the project’s IRR? 14% 15% 16%* 17%

8. Your rich aunt wants to retire in 20 years but is unsure of how much to invest now so that she can have $2,000,000 as a retirement fund. She is currently looking into markets that yield 8%. Calculate how much she should invest now. N = 20, I/Y = 8, PV = -429,096, PMT = 0, FV = 2,000,000 9. Suppose you borrowed $40,000 on a student loan at a rate of 9% and must now repay it in three equal installments at the end of each of the next three years. How large would your payments be, how much of the first payment would represent interest, how much would be principal, and what would your ending balance be after the first year? N = 3, I/Y = 9, PV = -40,000, PMT = 15,802.1903, FV = 0 Balance at Year 1 end = 27,797.8097 Interest at Year 1 end = 3,600.00

Principal at Year 1 end = 12,202.1903 10. Pearson Brothers recently reported an EBITDA of $8.5 million and $1.9 million of net income. The company has $2.5 million of interest expense and the corporate tax rate is 40%. What was the company’s depreciation and amortization expense? A. $3,166,667 B. $2,833,333 * C. $1,833,333 D. $1,266,667 EBITDA 8,500,000 DA 2,833,333 EBIT 5,666,667 I 2,500,000 EBT 3,166,667 Taxes 1,266,667 NI 1,900,000...