FINANCE

Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected. Old WACC: 10.00% New WACC: 8.00% Year 0 1 2 3 Cash flows -$1,000 $410 $410 $410 A. $37.00 B. $38.48 C. $32.19 D. $40.70

A. $37.00

You are considering buying a 14-year, semiannual-coupon bond that has a coupon rate of 8.25% and a YTM of 8.25%. What should be the price of this bond? A. $1, 000.00 B. $1, 106.08 C. $1, 128.46 D. $1, 997.19

A. $1, 000.00

Consider a 20-year, 8% semiannual coupon bond with a par value of $1,000. If the required rate of return on this bond is 7.5% what is the price of a bond? A. $1,051.38 B. $1,034.74 C. $643.19 D. $1,050.97

A. $1,051.38

Consider a 10-year, 9% annual coupon bond. If the required rate of return on this bond is 7.5% what is the price of a bond? A. $1,102.96 B. $794.08 C. $1,061.60 D. $1,104.22

A. $1,102.96

Cost of equity from retained earnings based on discounted dividend approach (D0)

(D0(1+g)/P0)+g

WACC when using cost of debt and equity

1. Solve for I/Y 2. After cost of debt = I/Y(1 - tax rate) 3. Cost of equity = r = rf + beta (MRP) 4. WACC = r = debt %

WACC

= wd x rd (1-t) + wp x rp + wc x rs

Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 9.75% Year 0 1 2 3 Cash flows -$1,000 $450 $450 $450 A. 14.11% B. 15.52% C. 15.81% D. 10.72%

A. 14.11%

Year Cash Flow (in millions) 0 -$750 1 $400 2 $300 3 $200 4 $400 The appropriate cost of capital for this project is 12% What is the project's payback period and discounted payback period? A. 2.25 years and 3.05 years, respectively B. 3.25 years and 4.05 years, respectively C. 2 years and 3 years, respectively D. 3.5 years and 3.56 years, respectively Year Cash Flow (in millions) Cumulative CFs Di

A. 2.25 years and 3.05 years, respectively

Dyl Inc.'s bonds currently sell for $970 and have a par value of $1,000. They pay a $65 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to maturity (YTM)? A. 6.83% B. 7.92% C. 5.26% D. 5.87%

A. 6.83%

A company's perpetual preferred stock currently sells for $105.00 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? A. 8.02% B. 6.18% C. 9.14% D. 9.70%

A. 8.02%

You were hired as a consultant to Giambono Company, whose 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 retained earnings is 11.50%. The firm will not be issuing any new stock. What is its WACC? A. 8.70% B. 8.87% C. 7.92% D. 7.66%

A. 8.70%

Tina Inc.'s bonds currently sell for $850. The bond pays interest of 6%, semiannually and have 7 years left to maturity. What is the yield to maturity on these bonds (YTM)? A. 8.93% B. 4.46% C. 11.31% D. 8.98%

A. 8.93%

OU Corp. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information: • The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,000.00. • The company's tax rate is 25%. • The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. • The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity. What is its WACC? Do not round your intermediate calculations. A. 9.32% B. 8.90% C. 10.32% D. 11.03%

A. 9.32%

Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D0 = $0.67; P0 = $47.50; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the discounted dividend approach? A. 9.52% B. 9.41% C. 8.19% D. 10.63%

A. 9.52%

The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time? A. The company will take on too many high-risk projects and reject too many low-risk projects. B. The company will take on too many low-risk projects and reject too many high-risk projects. C. Things will generally even out over time, and, therefore, the firm's risk should remain constant over time. D. The company's overall WACC should decrease over time because its stock price should be increasing.

A. The company will take on too many high-risk projects and reject too many low-risk projects.

For capital budgeting and cost of capital purposes, the firm should assume that each dollar of capital is obtained in accordance with its target capital structure, which for many firms means partly as debt, partly as preferred stock, and partly common equity. A. True B. False

A. True

We have identified two methods for estimating the cost of common stock from retained earnings: the CAPM method and the discounted dividend method. Since we cannot be sure that the estimate obtained with any of these methods is correct, it is often appropriate to use all two methods, then consider all two estimates, and end up using a judgmental estimate when calculating the WACC. A. True B. False

A. True

Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 12.00% Year 0 1 2 3 4 Cash flows -$1,200 $400 $425 $450 $475 A. $119.30 B. $118.12 C. $113.40 D. $121.67

B. $118.12

Stanley Corporation has 5.47% annual coupon bonds with a face value $1,500 outstanding. These bonds have 15 years left till maturity. Today, the market interest rate on these bonds 10.00%. What is the maximum price you would be willing to pay for this bond? A. $775.14 B. $983.17 C. $655.45 D. $977.72

B. $983.17

Sharpie Inc. pays its preferred stockholders a dividend of $1.25 every quarter. The current price of one of their preferred shares is $42.34. Sharpie pays 21% in corporate tax. What is the cost of its preferred shares? A. 2.95% B. 11.81% C. 9.33% D. 2.10%

B. 11.81%

. Sharpie Inc.'s bonds currently sell for $1,130.67. The bond pays interest of 7%, semiannually and have 20 years left to maturity. However, the bond can be called in 10 years at a call price of $1,100. What is the yield to call (YTC)? A. 3.00% B. 5.99% C. 5.30%% D. 5.88%

B. 5.99%

At what cost of capital would the NPV profiles of these two projects intersect? Year 0 1 2 3 4 5 6 Project 1 -$200K $20K $40K $100K $20K $50K $80K Project 2 -$200K $20K $40K $150K $10K $30K $50K A. 12.89% B. 8.21% C. 19.72% D. 11.90%

B. 8.21%

10. Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $47.50; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the discounted dividend approach? A. 9.52% B. 9.41% C. 8.19% D. 10.63%

B. 9.41%

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? A. A project's IRR increases as the WACC declines. B. A project's NPV increases as the WACC declines. C. A project's MIRR is unaffected by changes in the WACC. D. A project's regular payback increases as the WACC declines.

B. A project's NPV increases as the WACC declines.

Consider the following bonds. Bond RRR CR A 8% 6% B 7% 7% C 6% 8% If the yield-to-maturity is not expected to change, which of the following statements is CORRECT? A. Bond A will currently have a price higher than its face value and a negative capital gains yield. B. Bond B will sell at its par value and have a capital gains yield equal to zero. C. Bond C will currently have a price less than its face value and have a positive capital gains rate. D. Bond B will sell at its par value and have a positive capital gains rate.

B. Bond B will sell at its par value and have a capital gains yield equal to zero.

An investor would be thinking correctly if they decided to buy a particular type of bond because they thought that: A. Bond prices were about to fall due to a coming decrease in rates B. Bond prices were about to rise due to a coming decrease in rates C. Bond prices were about to fall due to a coming increase in rates D. Bond prices were about to rise due to a coming increase in rates

B. Bond prices were about to rise due to a coming decrease in rates

An investor would be thinking correctly if they decided to buy a particular type of bond because they thought that: A. Bond prices were about to fall due to a coming decrease in rates B. Bond prices were about to rise due to a coming decrease in rates C. Bond prices were about to fall due to a coming increase in rates D. Bond prices were about to rise due to a coming increase in rates

B. Bond prices were about to rise due to a coming decrease in rates

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt. A. True B. False

B. False

You are considering the following two mutually exclusive projects. If the cost of capital for both projects is 7%, which statement concerning capital-budgeting rules listed will be correct in this situation? Time Year 0 Year 1 Year 2 Year 3 Project A -$567 $300 $400 $300 Project B -$296 $500 $100 $50 A. Both NPV and IRR will choose the correct project(s). B. Neither NPV nor IRR will choose the correct project(s). C. NPV will choose the correct project(s), IRR will not. D. IRR will choose the correct project(s), NPV will not.

B. Neither NPV nor IRR will choose the correct project(s).

Project X's IRR is 19% and Project Y's IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT? A. The crossover rate must be less than 10%. B. The crossover rate must be greater than 10%. C. If the WACC is 8%, Project X will have the higher NPV. D. If the WACC is 18%, Project Y will have the higher NPV.

B. The crossover rate must be greater than 10%.

Project X's IRR is 19% and Project Y's IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT? A. The crossover rate must be less than 10%. B. The crossover rate must be greater than 10%. C. If the WACC is 8%, Project X will have the higher NPV. D. If the WACC is 18%, Project Y will have the higher NPV

B. The crossover rate must be greater than 10%.

Year Cash Flow (in millions) 0 -$750 1 $400 2 $300 3 $200 4 $400 The appropriate cost of capital for this project is 12% The NPV and the IRR of this project? A. $242.86 million and 20.14%, respectively B. $307.98 million and 29.86%, respectively C. $242.86 million and 27.19%, respectively D. $307.98 million and 12%, respectively

C. $242.86 million and 27.19%, respectively

McNellie's has the following data: risk free rate = 5.00%; expected market return = 9.00%; and beta = 1.50. What is the firm's cost of equity based on the CAPM? A. 10.92% B. 14.00% C. 11.00% D. 18.50%

C. 11.00%

McNellie's has the following data: risk free rate = 5.00%; market risk premium = 6.00%; and beta = 1.50. What is the firm's cost of equity based on the CAPM? A. 10.92% B. 12.46% C. 14.00% D. 14.98%

C. 14.00%

You are considering buying an 8-year, semiannual-coupon bond that has a coupon rate of 10.25% and YTM of 9%. What should be the current yield of this bond? A. 8.23% B. 8.88% C. 9.58% D. 9.90%

C. 9.58%

Consider the following bonds. Bond RRR CR A 8% 6% B 7% 7% C 6% 8% Which of the following statements is INCORRECT? A. Bond A is a discount bond. B. Bond B sells at par. C. Bond C is a discount bond. D. Bond A will have current market price less than its par value (face value).

C. Bond C is a discount bond.

Consider the following bonds. Bond RRR CR A 8% 6% B 7% 7% C 6% 8% Which of the following statements is INCORRECT? A. Bond A is a discount bond. B. Bond B sells at par. C. Bond C is a discount bond. D. Bond A will have current market price less than its par value (face value).dering the

C. Bond C is a discount bond.

Resnick Inc. is considering a project that has the following cash flow data. What is the project's payback? Year 0 1 2 3 Cash flows -$400 $200 $200 $200 A. 2.28 years B. 2.02 years C. 2.12 years D. 2.00 years

D. 2.00 years

Which of the following statements is CORRECT? A. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. B. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. C. If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. D. Higher flotation costs tend to reduce the cost of equity capital.

C. If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

A significant advantage of the payback period over NPV is A. It considers time value of money. B. It considers all the cash flows of a project. C. It is easy to understand and calculate. D. It properly accounts for the risk of the project.

C. It is easy to understand and calculate.

A significant advantage of the payback period over NPV is A. It considers time value of money. B. It considers all the cash flows of a project. C. It is easy to understand and calculate. D. It properly accounts for the risk of the project.

C. It is easy to understand and calculate.

Given below are information regarding the capital structure of LaFarge Inc. What should be the ideal weights that you should use to calculate the weighted average cost of capital of LaFarge? Book value Market value TCS Debt $60M $50M $50M Equity $40M $70M $50M A. wd = 60% for debt and ws = 40% for equity. B. wd = 41.67%% for debt and ws = 58.33% for equity. C. wd = 50% for debt and ws = 50% for equity. D. None of the above.

C. wd = 50% for debt and ws = 50% for equity.

Consider a 20-year, 8% annual coupon bond with a par value of $1,000. If the required rate of return on this bond is 7.5% what is the price of a bond? A. $1,051.38 B. $1,034.74 C. $643.19 D. $1,050.97

D. $1,050.97

Consider a 10-year, 9% semiannual coupon bond. If the required rate of return on this bond is 7.5% what is the price of a bond? A. $1,102.96 B. $794.08 C. $1,061.60 D. $1,104.22

D. $1,104.22

Expo Corporation issued 20-year, 7.1% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the maximum price you would be willing to pay for this bond? A. $1,114.58 B. $1,007.86 C. $1,090.86 D. $1,185.72

D. $1,185.72

Expo Corporation issued 20-year, 7.1% semiannual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the maximum price you would be willing to pay for this bond? A. $1,117.17 B. $1,185.72 C. $1,090.86 D. $1,187.14

D. $1,187.14

Stanley Corporation has 5.47% semiannual coupon bonds with a face value $1,500 outstanding. These bonds have 15 years left till maturity. Today, the market interest rate on these bonds is 10%. What is the maximum price you would be willing to pay for this bond? A. $767.50 B. $983.17 C. $651.81 D. $977.72

D. $977.72

Simkins Renovations Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected. Year 0 1 2 3 4 Cash flows -$825 $300 $290 $280 $270 A. 13.59% B. 17.24% C. 11.40% D. 14.61%

D. 14.61%

To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $875, 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? Do not round your intermediate calculations. A. 6.60% B. 7.77% C. 7.30% D. 8.09%

D. 8.09%

What is the yield to call for the bonds in Question 12, above? A. 6.83% B. 7.03% C. 7.23% D. 8.10%

D. 8.10%

MicroDrive has a stock which pays a $10 dividend every year. This stock currently trades at $120 per share. If MicroDrive issued new shares of stock, it would incur a flotation cost of $4.75 per share. What is MicroDrive's cost of newly issued stock? A. 8.33% B. 8.75% C. 4.32% D. 8.68%

D. 8.68%

You are evaluating a project which will cost $3,000 and has an expected future cash flow of $700 per year, forever, if it is started immediately. If you wait one year to start the project, the cost will increase to $3,500 and the expected future ash flows will increase to $795 per year (and continue to be so forever). If you wait two years to start the project, the cost will increase to $4,000 and the expected future cash flows will increase to $885 per year. If the required rate of return is 10%, what would your decision be? A. Reject the project. B. Begin the project immediately. C. Decide today to start the project in one year. D. Decide today to start the project in two years.

D. Decide today to start the project in two years.

Which of the following statements is CORRECT? A. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. B. All else equal, an increase in a company's stock price will increase its marginal cost of retained earnings, rs. C. All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re. D. If a company's tax rate increases but the YTM on its bonds remains the same, the after-tax cost of its debt will fall.

D. If a company's tax rate increases but the YTM on its bonds remains the same, the after-tax cost of its debt will fall.

Which of the following statements is CORRECT? A. If a project has "normal" cash flows, then its IRR must be positive. B. If a project has "normal" cash flows, then it will have exactly two real IRRs. C. The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. D. If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.

D. If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years tomaturity, and is not expected to default. The bond should sell at a premium if marketinterest rates are below 10% and at a discount if interest rates are greater than 10%. A. True B. False

True

The market value of any real or financial asset, including stocks, bonds, or art workpurchased in hope of selling it at a profit, may be estimated by determining future cashflows and then discounting them back to the present. A. True B. False

True

WACC calculator

Use I/Y

Current yield

annual coupon divided by bond price

Annual coupon

coupon rate x face value

Cost of preferred stock in other than annual periods

rp = (Dp/PP)*period

Cost of preferred stock

rp = Dp/(*Pp(1-F)

Cost of equity as new common stock

rs = D1(P0(1 - F) +g

Cost of newly issued stock

rs = D1/(P0 x (1 - F) + g

Cost of equity from retained earnings based on discounted dividend approach (D1)

rs = D1/P0+g

Cost of equity based on CAPM given market risk premium

rs = rRF + b(RPM)

Cost of equity based on CAPM given expected market premium

rs = rRF + b(rM - rRF)