Bond Valuation with Semiannual Payments

Renfro Rentals has issued bonds that have a 9% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of \$1,000, and a yield to maturity of 8.5%. What is the price of the bonds? Round your answer to the nearest cent.

You just purchased a bond that matures in 12 years. The bond has a face value of \$1,000 and a 7% annual coupon. The bond has a current yield of 5.74%. What is the bond’s yield to maturity? Do not round intermediate calculations.

Boehm Incorporated is expected to pay a \$4.00 per share dividend at the end of this year (i.e., D1 = \$4.00). The dividend is expected to grow at a constant rate of 3% a year. The required rate of return on the stock, rs, is 15%. What is the estimated value per share of Boehm’s stock? Do not round intermediate calculations.

Nick’s Enchiladas has preferred stock outstanding that pays a dividend of \$4 at the end of each year. The preferred sells for \$45 a share. What is the stock’s required rate of return (assume the market is in equilibrium with the required return equal to the expected return)?

Nonconstant Dividend Growth Valuation

A company currently pays a dividend of \$2 per share (D0 = \$2). It is estimated that the company’s dividend will grow at a rate of 23% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7%, and the market risk premium is 2.5%. What is your estimate of the stock’s current price? Do not round intermediate calculations.

CMS Corporation’s balance sheet as of today is as follows:

Long-term debt (bonds, at par) \$10,000,000

Preferred stock 2,000,000

Common stock (\$10 par) 10,000,000

Retained earnings 4,000,000

Total debt and equity \$26,000,000

The bonds have a 5.3% coupon rate, payable semiannually, and a par value of \$1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm’s debt?

a. \$6,155,867

b. \$6,155,012

c. \$6,156,722

d. \$6,157,576

e. \$6,158,431

Haswell Enterprises’ bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of \$1,000. The going interest rate (rd) is 10.25%, based on semiannual compounding. What is the bond’s price?

a. \$753.38

b. \$750.74

c. \$748.10

d. \$756.02

e. \$758.66

5-year Treasury bonds yield 6.3%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?

a. 3.73%

b. 4.81%

c. 4.54%

d. 4.00%

e. 4.27%

Question Workspace

A stock is expected to pay a dividend of \$0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 2%. What is the stock’s current price?

a. \$6.14

b. \$3.46

c. \$8.82

d. \$7.48

e. \$4.80

A stock just paid a dividend of D0 = \$1.50. The required rate of return is rs = 13.5%, and the constant growth rate is g = 4.0%. What is the current stock price?

a. \$17.70

b. \$18.34

c. \$18.98

d. \$16.42

e. \$17.06

Orwell building supplies’ last dividend was \$1.75. Its dividend growth rate is expected to be constant at 27.00% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?

a. \$44.93

b. \$43.98

c. \$45.88

d. \$43.03

e. \$46.83

Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of \$6.70 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

a. \$103.08

b. \$101.22

c. \$101.84

d. \$100.60

e. \$102.46

Portfolio Beta

Your investment club has only two stocks in its portfolio. \$45,000 is invested in a stock with a beta of 0.7, and \$55,000 is invested in a stock with a beta of 2.2. What is the portfolio’s beta? Do not round intermediate calculations. Round your answer to two decimal places.

Required Rate of Return

AA Corporation’s stock has a beta of 0.7. The risk-free rate is 2%, and the expected return on the market is 9%. What is the required rate of return on AA’s stock? Do not round intermediate calculations. Round your answer to one decimal place.

%

Required Rate of Return

Suppose rRF = 6%, rM = 11%, and rA = 10%.

If Stock A’s beta were 1.3, then what would be A’s new required rate of return? Round your answer to one decimal place.

%

Required Rate of Return

Stock R has a beta of 1.6, Stock S has a beta of 0.75, the expected rate of return on an average stock is 9%, and the risk-free rate is 4%. By how much does the required return on the riskier stock exceed that on the less risky stock? Do not round intermediate calculations. Round your answer to two decimal places.

%

After-Tax Cost of Debt

LL Incorporated’s currently outstanding 9% coupon bonds have a yield to maturity of 6.7%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 25%, what is LL’s after-tax cost of debt? Round your answer to two decimal places.

%

Cost of Preferred Stock with Flotation Costs

Burnwood Tech plans to issue some \$60 par preferred stock with a 7% dividend. A similar stock is selling on the market for \$75. Burnwood must pay flotation costs of 6% of the issue price. What is the cost of the preferred stock? Round your answer to two decimal places.

%

Cost of Equity: Dividend Growth

Summerdahl Resort’s common stock is currently trading at \$21 a share. The stock is expected to pay a dividend of \$1.25 a share at the end of the year (D1 = \$1.25), and the dividend is expected to grow at a constant rate of 4% a year. What is the cost of common equity? Round your answer to two decimal places.

%

Cost of Equity: CAPM

Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 3% and the yield on a 10-year T-bond is 7%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 13%. What is the estimated cost of common equity using the CAPM? Round your answer to two decimal places.

%

WACC

Shi Import-Export’s balance sheet shows \$300 million in debt, \$50 million in preferred stock, and \$250 million in total common equity. Shi’s tax rate is 25%, rd = 6%, rps = 5.1%, and rs = 12%. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 65% common stock, what is its WACC? Round your answer to two decimal places.

%

Donald Gilmore has \$100,000 invested in a 2-stock portfolio. \$42,500 is invested in Stock X and the remainder is invested in Stock Y. X’s beta is 1.50 and Y’s beta is 0.70. What is the portfolio’s beta?

a. 0.92

b. 0.95

c. 0.98

d. 1.01

e. 1.04

Zacher Co.’s stock has a beta of 0.72, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm’s required rate of return?

a. 7.81%

b. 8.01%

c. 8.21%

d. 8.41%

e. 8.61%

Porter Plumbing’s stock had a required return of 12.50% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm’s beta remain unchanged. What is the company’s new required rate of return? (Hint: First calculate the beta, then find the required return.)

a. 15.45%

b. 13.45%

c. 13.95%

d. 14.45%

e. 14.95%

Fiske Roofing Supplies’ stock has a beta of 1.23, its required return is 9.50%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

a. 8.53%

b. 8.61%

c. 8.69%

d. 8.77%

e. 8.85%

Kenny Electric Company’s noncallable bonds were issued several years ago and now have 20 years to maturity. These bonds have a 9.25% annual coupon, paid semiannually, sells at a price of \$1,075, and has a par value of \$1,000. If the firm’s tax rate is 25%, what is the component cost of debt for use in the WACC calculation?

a. 5.44%

b. 6.35%

c. 5.73%

d. 6.03%

e. 6.67%

Perpetual preferred stock from Franklin Inc. sells for \$97.50 per share, and it pays an \$8.50 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. What is the company’s cost of preferred stock for use in calculating the WACC?

a. 9.08%

b. 10.22%

c. 9.44%

d. 8.72%

e. 9.82%

When working with the CAPM, which of the following factors can be determined with the most precision?

a. The most appropriate risk-free rate, rRF.

b. The beta coefficient of “the market,” which is the same as the beta of an average stock.

c. The beta coefficient, bi, of a relatively safe stock.

d. The expected rate of return on the market, rM.

e. The market risk premium (RPM).

Bartlett Company’s target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using reinvested earnings is 12.75%. The firm will not be issuing any new stock. You were hired as a consultant to help determine their cost of capital. What is its WACC?

a. 9.26%

b. 8.98%

c. 9.83%

d. 10.12%

e. 9.54%

Avery Corporation’s target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of common from reinvested earnings is 11.25%, and the tax rate is 25%. The firm will not be issuing any new common stock. What is Avery’s WACC?

a. 8.49%

b. 9.19%

c. 9.94%

d. 9.55%

e. 8.83%

NPV

A project has an initial cost of \$50,000, expected net cash inflows of \$10,000 per year for 8 years, and a cost of capital of 11%. What is the project’s NPV? (Hint: Begin by constructing a time line.) Do not round intermediate calculations. Round your answer to the nearest cent.

\$

NPVs, IRRs, and MIRRs for Independent Projects

Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The cash outlay for the truck is \$18,000, and that for the pulley system is \$22,000. The firm’s cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:

Year Truck Pulley

1 \$5,100 \$7,500

2 5,100 7,500

3 5,100 7,500

4 5,100 7,500

5 5,100 7,500

Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept/reject decision for each. Do not round intermediate calculations. Round the monetary values to the nearest dollar and percentage values to two decimal places. Use a minus sign to enter negative values, if any.

NPVs and IRRs for Mutually Exclusive Projects

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost \$21,500, whereas the gas-powered truck will cost \$17,960. The cost of capital that applies to both investments is 13%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be \$6,860 per year, and those for the gas-powered truck will be \$4,600 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck, and decide which to recommend. Do not round intermediate calculations. Round the monetary values to the nearest dollar and percentage values to two decimal places.

The firm should purchase -electric-powered or gas-powered forklift truck.

Capital Budgeting Methods

Project S has a cost of \$11,000 and is expected to produce benefits (cash flows) of \$3,400 per year for 5 years. Project L costs \$23,000 and is expected to produce cash flows of \$6,900 per year for 5 years.

Calculate the two projects’ NPVs, assuming a cost of capital of 14%. Do not round intermediate calculations. Round your answers to the nearest cent.

Project S: \$

Project L: \$

Which project would be selected, assuming they are mutually exclusive?

Based on the NPV values, -Select-Project SProject LItem 3 would be selected.

Calculate the two projects’ IRRs. Do not round intermediate calculations. Round your answers to two decimal places.

Project S: %

Project L: %

Which project would be selected, assuming they are mutually exclusive?

Based on the IRR values, Select:Project S or Project L would be selected.

Calculate the two projects’ MIRRs, assuming a cost of capital of 14%. Do not round intermediate calculations. Round your answers to two decimal places.

Project S: %

Project L: %

Which project would be selected, assuming they are mutually exclusive?

Based on the MIRR values, Select:Project S or Project L would be selected.

Calculate the two projects’ PIs, assuming a cost of capital of 14%. Do not round intermediate calculations. Round your answers to three decimal places.

Project S:

Project L:

Which project would be selected, assuming they are mutually exclusive?

Based on the PI values, Select:Project S or Project L would be selected.

Which project should actually be selected

Select:Project S or Project L should actually be selected.

Project Cash Flow

The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service:

The company faces a 25% tax rate. What is the project’s operating cash flow for the first year (t = 1)? Enter your answer in dollars. For example, an answer of \$1.2 million should be entered as \$1,200,000. Round your answer to the nearest dollar.

\$

Net Salvage Value

Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost \$8.5 million, of which 80% has been depreciated. The used equipment can be sold today for \$3.4 million, and its tax rate is 25%. What is the equipment’s after-tax net salvage value? Enter your answer in dollars. For example, an answer of \$1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.

\$

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is \$860,000, and it would cost another \$20,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for \$454,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of \$13,000. The sprayer would not change revenues, but it is expected to save the firm \$352,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 25%. (Ignore the half-year convention for the straight-line method.) Cash outflows, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

· What is the Year-0 net cash flow? \$

· What are the net operating cash flows in Years 1, 2, and 3?

· What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)? \$

· If the project’s cost of capital is 11%, what is the NPV of the project? \$ Should the machine be purchased?

· Yes or no

Scott Enterprises is considering a project that has the following cash flow and cost of capital (r) data. What is the project’s NPV? Note that if a project’s expected NPV is negative, it should be rejected.

a. \$81.56

b. \$77.49

c. \$94.66

d. \$85.86

e. \$90.15

Reed Enterprises is considering a project that has the following cash flow and cost of capital (r) data. What is the project’s NPV? Note that a project’s expected NPV can be negative, in which case it will be rejected.

a. \$101.84

b. \$112.28

c. \$96.99

d. \$92.37

e. \$106.93

Hart Corp. is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s IRR can be less than the cost of capital or negative, in both cases it will be rejected.

a. 15.29%

b. 13.21%

c. 12.55%

d. 14.56%

e. 13.87%

Nichols Inc. is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s IRR can be less than the cost of capital or negative, in both cases it will be rejected.

a. 10.92%

b. 11.47%

c. 9.43%

d. 10.40%

e. 9.91%

Computer Consultants Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project’s MIRR? Note that a project’s MIRR can be less than the cost of capital (and even negative), in which case it will be rejected.

a. 10.35%

b. 11.50%

c. 9.32%

d. 12.78%

e. 14.20%

Worthington Inc. is considering a project that has the following cash flow data. What is the project’s payback?

a. 2.03 years

b. 2.25 years

c. 2.75 years

d. 2.50 years

e. 3.03 years

Craig’s Car Wash Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project’s discounted payback?

a. 2.09 years

b. 2.29 years

c. 1.88 years

d. 2.78 years

e. 2.52 years

You have just landed an internship in the CFO’s office of Hawkesworth Inc. Your first task is to estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow?

Sales revenues \$13,000

Depreciation \$4,000

Other operating costs \$6,000

Tax rate 25.0%

a. \$6,566

b. \$6,250

c. \$6,406

d. \$6,899

e. \$6,731

Your new employer, Freeman Software, is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project’s 10-year expected life. What is the Year 1 cash flow?

Equipment cost (depreciable basis) \$65,000

Sales revenues, each year \$60,000

Operating costs (excl. deprec.) \$25,000

Tax rate 25.0%

a. \$36,869

b. \$35,114

c. \$33,442

d. \$31,666

e. \$31,849

Question Workspace

Century Roofing is thinking of opening a new warehouse, and the key data are shown below. The company owns the building that would be used, and it could sell it for \$100,000 after taxes if it decides not to open the new warehouse. The equipment for the project would be depreciated by the straight-line method over the project’s 3-year life, after which it would be worth nothing and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)

Project cost of capital (r) 10.0%

Opportunity cost \$100,000

Net equipment cost (depreciable basis) \$65,000

Straight-line deprec. rate for equipment 33.333%

Sales revenues, each year \$123,000

Operating costs (excl. deprec.), each year \$25,000

Tax rate 25%

a. \$31,254

b. \$29,691

c. \$26,796

d. \$32,817

e. \$28,207

Nonconstant Dividend Growth Valuation
Total:
\$8.99