FA22 - Prin Of Fin Mgmt FINC-3301-030/Prin Of Fin Mgmt FINC-3301-031 - EXAM 3 PREP

The MCC schedule's list of proposed capital budgeting projects is referred to as a firm's ______ opportunity schedule (IOS).

investment

The constant growth dividend valuation model for common stock can best be described as _______________.

P0 = D1 / (rs - g)

In your bond formulas, what is the entry for the FV?

$1000 (The par price of the bond is returned at the end)

Assume the risk-free rate is 3.3%, the expected rate of return on the market is 9.4%, and the beta of your firm is -1.0. Given these conditions, what is the required rate of return on your company's stock per the capital asset pricing model? Do NOT include the % sign in your answer. Do include 2 decimals. Example: An answer of 25.99% would be entered as 25.99 (Do NOT enter .2599)

-2.8

Sandia corporation is considering two mutually exclusive projects. For our purposes, we will call them projects A and B. Project A is expected to cost $51,918, and project B is expected to cost $52,978. Each project's expected cash flows are presented below. Both project A and B have similar risks to all other projects at Sandia. And the weighted average cost of capital for Sandia is 9.40%. Calculate the net present value of both projects, and enter in the box below how much the value of the firm is expected to increase based on this capital budget (please enter the amount to the nearest penny). Project AProject B Year 1 (A)$8,135(B)$7,873 Year 2(A)$12,918(B)$13,648 Year 3(A)$12,866(B)$10,589 Year 4(A)$11,934(B)$10,471 Year 5(A)$15,452(B)$15,368

0

Calculate the price of a seven-year $1000 bond with a $80 annual coupon payment and a YTM of 7%. Include two decimals in your answer.

1,053.89

You want to increase the diversity of your current investment portfolio by adding a few different Corporate Bonds. One of the bonds you are looking at matures in 22 years, yields 9.76% and has a coupon rate of 12% paid semiannually. If the par value equals $1,000, what is the most you should be willing to pay for each bond? Round your answer to the nearest penny.

1,201.3

You want to increase the diversity of your current investment portfolio by adding a few different Corporate Bonds. One of the bonds you are looking at matures in 29 years, yields 7.02% and has a coupon rate of 9% paid semiannually. If the par value equals $1,000, what is the most you should be willing to pay for each bond? Round your answer to the nearest penny.

1,243.91

If a project costs $8,819, and has the cash flows outlined in the table below, what is this project's payback period in years (use two decimal places in your response)? Year 1 7,105 Year 2 5,065 Year 3 2,783 Year 4 4,932 Year 5 5,935

1.34

A bond with a 10% coupon selling at par, has a YTM of ______.

10%

African Queen River Tours, Inc. has capitalized on the renewed interest in riverboat travel. Charlie Allnut, the lone financial analyst, estimates the firm's earnings, dividends, and stock price will continue to grow at the historical 5.0% rate. AQRT's common stock is currently selling for $30 per share. The yearly dividend previously paid was $1.6. The rate of return expected on the overall stock market is 12.3%. If they issue new common stock today and pay flotation costs of $2 per share, what is the cost of the new common equity for AQRT?

11

The current listed price per share of the Kings Corporation's stock is $28. The cash dividend expected from this corporation in one year is $2.23 per share. All market research indicates that the expected constant growth rate in dividends will be 3.3% per year in future years. What is the rate of return on this investment that an investor can expect if shares are purchased at the current listed price? Enter your answer without the percentage sign and with 2 decimals. Example, if the answer is 25.9%, enter 25.9 Do not enter .259

11.26

Find the internal rate of return (IRR) for a proposed project costing $12,798. Assume that the estimated cash flows for the life of the project are found in the table below. Please format your answer without the % symbol (i.e. for 20.22 %, you would simply enter 20.22), and include two decimal places. t1 4,466 t25,516 t32,874 t42,114 t52,372

13.19

General Lithograph Corporation uses no preferred stock. Their capital structure uses 21% debt (hint: the rest is equity). Their marginal tax rate is 28.75%. Their before-tax cost of debt is 4.90%. General Lithograph's stock is expected to pay a dividend per share of $1.69 next year, and their dividend is expected to grow at 7.98% over the long-run. Their stock currently trades at $18.58 per share. What is General Lithograph's weighted average cost of capital (WACC)? Please enter without using the "%", but with two decimal places (in other words if you calculate 9.87%, then just enter 9.87).

14.22

The current listed price per share of the Kings Corporation's stock is $23. The cash dividend expected from this corporation in one year is $3.22 per share. All market research indicates that the expected constant growth rate in dividends will be 3.7% per year in future years. What is the rate of return on this investment that an investor can expect if shares are purchased at the current listed price? Enter your answer without the percentage sign and with 2 decimals. Example, if the answer is 25.9%, enter 25.9 Do not enter .259

17.7

A share of Bauer Bowties Inc. common stock is expected to pay a dividend of $1.13 at the end of this year. If the expected long-run growth rate for this stock is 5.06%, and if investors' required rate of return is 10.85% what is the appropriate stock price today (give me the price to the penny)?

19.52

A share of Bauer Bowties Inc. common stock is expected to pay a dividend of $1.06 at the end of this year. If the expected long-run growth rate for this stock is 2.89%, and if investors' required rate of return is 7.43% what is the appropriate stock price today (give me the price to the penny)?

23.35

Toasties Inc. just paid a dividend of $1.57. If the expected long-run growth rate for their stock is 3.68%, and if investors' required rate of return is 9.54% what is the appropriate stock price today for Toasties?

27.78

Find the modified internal rate of return (MIRR) for a proposed project costing $8,571 (if you calculate an MIRR of 20.22%, please enter 20.22 - do not include the % symbol, and use at least two decimal places). Assume that the appropriate cost of capital for projects of this risk level, at this company is 14.09%, and the estimated cash flows for the life of the project are as follows: Year 1 $3,889 Year 2 $5,917 Year 3 $6,394 Year 4 $4,212 Year 5 $6,363

32.4

Toasties Inc. just paid a dividend of $2.26. If the expected long-run growth rate for their stock is 2.00%, and if investors' required rate of return is 8.77% what is the appropriate stock price today for Toasties? Give me the price to the penny

34.05

A firm is considering an investment of stock from TB Customs, Inc., which has a beta of 0.1. Treasury Bills are currently yielding 3.9% and the expected market return is 9.8%. Calculate the cost of capital for TB Customs according to the CAPM. State your answer with two decimals and do NOT enter the % sign. Example: If the answer is 25.92%, enter 25.92. Do NOT enter .02592

4.49

Assume the risk-free rate is 4.1%, the expected rate of return on the market is 5.2%, and the beta of your firm is 0.8. Given these conditions, what is the required rate of return on your company's stock per the capital asset pricing model? Do NOT include the % sign in your answer. Do include 2 decimals. Example: An answer of 25.99% would be entered as 25.99 (Do NOT enter .2599)

4.98

You are seriously considering an investment in Zero Coupon Bonds. The specific bond you are evaluating has a face value of $4,239 and matures in 19 years. What would be the most you should be willing to pay per bond if the appropriate discount rate for this security equals to 13.14%? Round your answer to the nearest penny. Note: This is an example of a bond with a face or par value that is NOT $1000 and no PMT to be entered. Remember that the FV of a bond is equal to the Face Value.

406.03

The George's Foundation preferred stock is paying a dividend of $3.0 and has a required return of 6.8%. Calculate its price to the nearest penny.

44.12

You are seriously considering an investment in Zero Coupon Bonds. The specific bond you are evaluating has a face value of $1,739 and matures in 11 years. What would be the most you should be willing to pay per bond if the appropriate discount rate for this security equals to 10.36%? Round your answer to the nearest penny. Note: This is an example of a bond with a face or par value that is NOT $1000 and no PMT to be entered. Remember that the FV of a bond is equal to the Face Value.

587.99 Remember that the FV of a bond is the same amount as the Face (Coupon) Price of the Bond. It's the amount originally paid for the bond and received back at the end of the bond period. Formula for Zero Coupon Bond Current Price =-PV(RATE,NPER,0 PMT,FV)

Smart Labs Technologies is expected to pay a dividend of $2 per share next year, $2.7 on year 2, and $3.2 on year 3. After that, dividends will have a constant growth of 3% annually. The required rate of return for this stock is 8%. Given this information, what would be the share price for this firm? Round your answer to two decimals and enter your answer in the box below.

59.04

Smart Labs Technologies is expected to pay a dividend of $2.1 per share next year, $2.8 on year 2, and $3.3 on year 3. After that, dividends will have a constant growth of 3% annually. The required rate of return for this stock is 8%. Given this information, what would be the share price for this firm? Round your answer to two decimals and enter your answer in the box below.

60.93

The George's Foundation preferred stock is paying a dividend of $4.2 and has a required return of 6.6%. Calculate its price to the nearest penny. Correct!

63.63

Calculate the WACC given the following information: After-tax cost of debt 4.7% Cost of preferred stock 10.3% Cost of common Stock 11.1% Capital Structure: Debt = 50%, Preferred Stock = 5%, Common Stock = 45%

7.86

Calculate the price of a seven-year $1000 bond with a $40 annual coupon payment and a YTM of 8%. Include two decimals in your answer.

791.75

Jake's June Bugs, Inc. is offering $1000 par value bonds for sale. The bonds will mature in 15 years. The annual coupon interest rate is 8%, with payments to be made annually. You just purchased one of these bonds for the current market price of $980 What is the current market rate of this bond? Include two decimals in your answer, do NOT include the % sign. (Example: enter 9.85 for 9.85%. Do NOT enter .0985)

8.24 (with margin: 0.02)

Clancy Submarines, Inc. is offering $1000 par value bonds for sale. The bonds will mature in 10 years. The annual coupon interest rate is 12%, with payments to be made annually. You just purchased one of these bonds for the current market price of $1,125 What is the current market rate of this bond? Include two decimals in your answer, do NOT include the % sign. (Example: enter 9.85 for 9.85%. Do NOT enter .0985)

9.97

Two best friends, Thelma and Louise, are making long-range plans for a road trip vacation to Mexico. They will embark on this adventure in five years and want to invest during the five-year period to earn money for the trip. They decide to purchase a $1000 Grand Canyon Oil Company bond with an annual coupon rate of 10 percent with interest to be paid annually. The bond will mature in five years. The YTM of similar bonds is 8%. How much should they be willing to pay for the bond if they purchase it today? Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters

=-PV(8%,5,100,1000) =PV(8%,5,-100,-1000)

Find the net present value (NPV) for a proposed project costing $22,748. Assume that the appropriate cost of capital for projects of this risk level, at this company is 12.56%, and the estimated cash flows for the life of the project are as follows: Period Initial Investment and Cash Flows Year 0- $22,748 Year 1$ 4167 Year 2$ 8524 Year 3$ 5798 Year 4$ 4758 Please enter the formula for your answer, exactly as you would enter it in Excel. Use all capital letters in your formula and enter the rate as a percentage. Example: =PMT(3%,8,-500,0)

=NPV(12.56%,4167,8524,5798,4558)+(-22748) =NPV(12.56%,4167,8524,5798,4758)-22748

Calculate the price of a seven-year $1000 bond with an $50 annual coupon payment and a YTM of 7%. Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters. Correct!

=PV(.07,7,-50,-1000) =-PV(7%,7,50,1000) =-PV(.07,7,50,1000) =-PV(0.07,7,50,1000) =PV(7%,7,-50,-1000) =PV(0.07,7,-50,-1000)

Calculate the price of a seven-year $1000 bond with an $50 annual coupon payment and a YTM of 7%. Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters.

=PV(0.07,7,-50,-1000) =-PV(7%,7,50,1000) =PV(7%,7,-50,-1000) =-PV(.07,7,50,1000) =-PV(0.07,7,50,1000) =PV(.07,7,-50,-1000)

Two best friends, Thelma and Louise, are making long-range plans for a road trip vacation to Mexico. They will embark on this adventure in five years and want to invest during the five-year period to earn money for the trip. They decide to purchase a $1000 Grand Canyon Oil Company bond with an annual coupon rate of 10 percent with interest to be paid annually. The bond will mature in five years. The YTM of similar bonds is 8%. How much should they be willing to pay for the bond if they purchase it today? Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters.

=PV(8%,5,-100,-1000) =-PV(8%,5,100,1000)

The Merit Corporation has issued a set of bonds that matures in 15 years, has a coupon rate of 8% paid monthly, and a current price of $1,350 per bond. If the par value equals $1,000, what is current YTM of the set of bonds? Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters

=RATE(180,6.67,-1350,1000)*12 =RATE(15*12,-80/12,1350,-1000)*12 =RATE(15*12,80/12,-1350,1000)*12 =RATE(180,-6.67,1350,-1000)*12

The Merit Corporation has issued a set of bonds that matures in 15 years, has a coupon rate of 8% paid monthly, and a current price of $1,350 per bond. If the par value equals $1,000, what is current YTM of the set of bonds? Enter the excel formula you would use to solve this problem. Example: =PMT(3%,8,-500,0) Do NOT put any spaces in your formula and use capital letters.

=RATE(180,6.67,-1350,1000)*12 =RATE(180,-6.67,1350,-1000)*12 =RATE(15*12,80/12,-1350,1000)*12 =RATE(15*12,-80/12,1350,-1000)*12

What are some things that would cause the WACC to change?

Basically anything that affects the cost the firm is paying for capital. Interest rates could rise or fall, stockholder's could become more rise adverse, tax rates could be changed, the economy could take a upswing, or maybe a major pandemic could arise and play havac on the whole world of business. By the way, these would all be classified as systemic (undiversifiable) risks, because they would affect all businesses. There could also be industry or business specific risks that could affect a firm's WACC. A bad loan deal could lower a firm's ability to attain low interest loans - this would raise the firm's cost of debt. Unethical behavior from the firm's management might give the firm an undiserable reputation, which might make the firm's stock less desirable.

Which of the following statements is true of Capital Budgeting?

Capital budgeting techniques are used to evaluate a firm's fixed asset investments which provide the basis for the firm's earning power and value.

What two growth patterns of common stock are discussed in the textbook?

Constant Growth Dividends and Nonconstant Growth Dividends.

The firm's ________ _____ ________ when it borrows money by issuing bonds is the interest rate demanded by bond investors.

Flotation

When a company issues new securities, how do flotation costs affect the cost of raising the capital?

Flotation costs increase the cost of raising the capital. The company receives a smaller amount of the proceeds from the new issue.

The projected rate of return that a proposed project will earn, given its incremental cash flows and required initial cash outlay, is called the ______ ______ __ ______.

IRR Internal rate of return

Which of the following is true for a bond?

If the YTM is less than the coupon rate, the bond will sell at a premium.

Why is debt considered on an after-tax basis while stock is not?

Interest paid on debt can be tax-deductible while dividends paid to shareholders are NEVER tax deductible.

How does the Investment Opportunity Schedule (IOS) help financial managers make business decisions?

It allows financial managers to examines several projects at once, all ranked by the highest expected returns.

When a bond has a YTM greater than its coupon rate, it sells at a "what"?

It sells at a discount

What is the "weight" referred to in the weighted average cost of capital?

It's the portion of the total capital raised by the firm that comes from a given source such as dept, preferred stock, or common stock equity.

The project selection method that is the most consistent to the goal of owner wealth maximization is the ______ method.

NPV

The four formal capital budgeting decision methods are payback, _____ ______ _____, internal rate of return, and modified internal rate of return.

NPV net present value

Which capital budgeting method is a measure of the project's impact on the firm's value

NPV - Net Present Value calculates the present value of the investment.

Do all corporations issue preferred stock?

No. Corporations must issue common stock, but preferred stock is not required. Most corporations do NOT have preferred stock.

How is preferred stock similar to a debt obligation?

Preferred stock obligates the firm to pay a fixed dividend to each shareholder, much like interest payments on long-term bonds.

Why would a firm use the CAPM to measure the cost of equity as opposed to the Gordon Growth Model?

The CAPM can be used when firms have dividends that grow at a changing rate, no dividends, or when the firm wants to take market risk into consideration.

What is another name for the Constant Dividend Growth Model

The Gordon Growth Model

When is it appropriate to use the Constant (Gordon) Growth Model to measure the cost of equity?

The Gordon Growth Model is used when corporations pay regular dividends that grow at a constant rate.

What is the Investment Opportunity (IOS)?

The IOS is a list of proposed capital budgeting projects ranked by their expected rate of return.

If a bond is purchased and held to maturity, what is the YTM of the bond?

The YTM would be equal to the original coupon rate of the bond. (When a bond is held to maturity, the price and rate never change).

What is the assumption of the Constant Growth Dividend Model?

The assumption of the dividend growth dividend model is that stock dividends will be paid regularly and grow at a constant rate.

How do you determine (calculate) the cash flow of a bond?

The bond's coupon rate multiplied by the bond's par price ($1000).

What are the main sources of capital for public corporations

The main sources of capital are the sale of long-term bonds, borrowing from lenders, and the sale of stock or use of retained earnings.

What is the Marginal Cost of Capital (MCC), and how is it important in making financial decisions?

The marginal cost of capital (MCC) is the weighted average cost for the firm's next dollar of financing. A firm's weighted average cost of capital changes as the cost of debt or equity increases and as more capital is raised. Financial managers calculate the break points in the capital budget size at which the MCC will change. There will always be an equity break point, which depends on the amount of internal equity available. There may be one or more debt break points, and so on. The financial manager first calculates each WACC and each breakpoint and plots the MCC values on a graph showing how the cost of capital changes as capital budget size changes. The financial manager creates an Investment Opportunity Schedule (IOS) by lining up all potential capital budgeting projects from highest IRR to lowest, and plots the IOS on the same graph with the MCC. To increase the value of the firm, projects on the IOS line that are above the MCC line should be accepted and those below the MCC line rejected. The marginal cost of capital schedule forces financial managers to match the project's rate of return with the cost of funds for that specific project. This marginal analysis prevents financial managers from estimating a project's value incorrectly because of faulty cost of capital estimates that fail to consider how a larger capital budget increases capital costs. By analyzing the combined IOS and MCC schedule together, financial managers can examine many projects together to choose the best combination of projects for the firm.

What is the Weighted Average Cost of Capital (WACC) and why is it important?

The weighted average cost of capital, or WACC , is the overall average cost of funds. It takes into consideration each of the component capital costs and the weight of each of those components in the firm's capital structure. To estimate the WACC, you must first calculate the weights (percentages) of each type of capital in the capital structure. For each type of capital, this is calculated as the dollars of that form of capital divided by the total capital being used by the firm. Using those weights, the formula for calculating the WACC is: WACC = (weight of debt * after-tax cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)In order for a firm to make efficient capital budgeting decisions, it must first understand what it is currently paying for its capital. The WACC tells the firm this. The firm only wants to take on projects that will add value. If a project does not have a return that is equal to or greater than the cost of capital, then it will NOT add value to the firm. A project generating less than the WACC will decrease the value of the firm. In other words, the firm must earn a return equal to the WACC in order to pay suppliers of capital the returns they expect.

When does a bond sell at a premium?

When the YTM is less than the coupon rate.

How do you calculate the yield on preferred stock?

Y = Dividend / Price

______ __ _____ represents the average rate of return on a bond if all promised interest and principal payments are made on time and if the interest payments are reinvested at the interest rate given the price paid for the bond.

YTM or Yield To Maturity

What is the YTM of a bond?

Yield to Maturity is the average annual rate of return that investors realize when bonds are bought and held to maturity.

When a bond has a YTM greater than its coupon rate, it sells at a _____.

discount

Cash payments from preferred stock dividends are scheduled to continue ______.

forever

The cost of equity is _______ than the cost of debt financing because debt-providers bear less risk than equity providers.

greater

A cash flow that will occur if a project is undertaken but will not occur if the project is not undertaken is an ________ cash flow to the project.

incremental relevant

Capital budgeting decisions are based on ______ cash flows.

incremental relevant

The relationship between the NPV of a project and the cost of funds is ______, meaning the higher the cost, the lower the NPV, and the lower the cost, the higher the NPV.

inverse

Although the NPV and IRR methods may produce conflicting rankings, for independent projects, both methods will produce the same ______ indication.

accept/reject

Funds that are used by firms to increase assets are called ______.

capital

____ ____ is the process of evaluating proposed large, long-term investment projects.

capital budgeting

______ stock dividend payments change from year to year and may not be paid at all.

common

The firm's ________ is the appropriate discount rate to use in capital budgeting models.

cost of capital

A firm's capital is supplied by its ______ and owners.

creditors investors lenders

All else equal, a firm with low levels of debt may prefer debt financing because:

debt financing has tax advantages

Common stock dividends can grow at ______ rates.

irregular

A tax adjustment must be made in determining the cost of ________.

long term debt

The IRR decision rule is that those projects that have IRRs equal to or greater than the hurdle rate set by ______are accepted.

management

The TCJA of 2017 will have a severe ______ impact on businesses with lots of debt on their balance sheets.

negative

The equity break point is the point at which the firm has exhausted additions to retained earnings and must issue _____ equity to maintain the optimal equity proportion in its capital structure.

new additional more

A conventional cash flow pattern associated with capital investment projects consists of an initial ________.

outflow followed by a series of inflows

Common stockholders ______ the firm.

own

Common stock valuation is complicated by the fact that common stock dividends are difficult to _____ compared with the interest and principal payments on a bond or dividends on preferred stock.

predict

The yield on preferred stock can be calculated by dividing the amount of the periodic dividends by the market value _____ of the stock.

price

The cost of equity is higher than the cost of debt because a company's lenders have a ______claim on the earnings of the firm and on its assets in the event of a liquidation.

prior

Conflicts between decision methods occasionally arise when projects are mutually exclusive; in such a case, the one with the highest _______ should be chosen.

ranking

For projects that are determined to be riskier than average, _____-_____ discount rates (RADRs) should be used to calculate NPV and to evaluate IRR.

risk adjusted

The ________ reflects the return that must be earned on a given project to compensate the firm's owners adequately concerning the riskiness of the project.

risk adjusted discount rate

The IRR is the point on the NPV profile where ___________.

the NPV equals 0

What is the Yield to Maturity of a bond?

the average rate of return for the bond

All other things held constant, how would the market price of a bond be affected if coupon interest payments were made weekly instead of annually.

the market price would go down

If a firm finances a new project entirely with debt capital, but has debt and equity in its optimal capital structure, it should _________.

use the weighted average cost of capital of its optimal capital structure as the required rate of return for the new project

The ______ ______ ______ __ ______ is the average of all the component costs of capital, weighted according to the percentage of each component in the firm's optimal capital structure.

weighted average cost of capital or WACC