Finance Ch 7-9
A firm is planning a project that will both expand the firm's operations and replace some of the older, less efficient assets of the firm. The new assets will cost the firm $200,000 plus an additional $5,000 for delivery and $25,000 for installation. Old assets being replaced have a book value of $50,000 and can be sold pre-tax for $40,000. The new project will require additional land. The land to be used was purchased three years ago for $75,000 but could be sold today for $140,000 net of taxes. The new project will require an increase of $20,000 in net working capital immediately. What is this project's net investment? Use 40% for the effective tax rate.
$346,000
Jabbar Hotels Incorporated currently pays a $3.00 common stock dividend. Dividends have been growing at a 5% annual rate and are expected to continue growing a this rate into the foreseeable future. What is the current value of Jabbar Hotels common stock to an investor requiring a 12% rate of return?
$45.00
Lapidus Restaurants Incorporated currently pays a $5.00 common stock dividend. The dividend is expected to remain at $5.00 and not expected to grow in the future. What is the current value of Lapidus Restaurants common stock to an investor requiring an 11% rate of return?
$45.45
Dolci's Theme Parks currently pays a $1.00 common stock dividend. Dividends have been growing at a 5% annual rate and are expected to continue growing at this rate for the next 2 years. Thereafter the growth rate is expected to be 0% for the foreseeable future. What is the current value of Dolci common stock to an investor requiring a 16% rate of return?
$6.85
Ranch Resort & Spa has recently purchased new furniture for its rooms, totalling US$ 3,150,000 (excluding taxes etc.). Sales taxes are 6%, to be added to the overall costs. The room furniture will be depreciated in five years using the straight-line depreciation method. The hotel plans to sell the furniture for $150,000 after 5 years. The book value at the end of the fifth year is US$ 125,000. Based on this information, the annual depreciation of the kitchen appliances will be:
$642,800
Tokyo Food Supplies Corporation is considering an expansion to a new market. Tokyo Food Supplies has already conducted and paid $35,000 for a marketing survey. The expansion will cost $400,000 for new assets, another $25,000 for shipping and delivery costs, and another $70,000 for installation costs. In addition, $150,000 in net working capital will be needed immediately. Compute the net investment.
$645,000
Riverside Safari Resort has recently purchased 5 luxury SUV's for US$ 55,000 each (including taxes etc.). These cars will be depreciated in four years using the straight-line depreciation method. The book value of these vehicles at the end of the third year is together US$ $25,000. Based on this information, the annual depreciation of these vehicles will be:
$68,750
Triple A Hotels expects a growth rate of 7% in the next two years, and a 8% constant years in the years thereafter. The dividend to be paid in one year (d1) amounts to $2.75. Investors require a 12% rate of return. Based on the available information, the present value of the common stock is equal to:
$68.14
The Summer Heritage Resort & Spa has a hotel project that, if executed, will cause the company's cash flow to increase annually from $55 million to $62 million. For the capital budgeting decision-making, the company has to consider the following cash flow amount:
$7 million increase
Seashore Hotel is planning a project that is expected to increase its sales revenues by $250,000 on an annual basis. In addition, its cash expenses will increase by $75,000 annually, while its depreciation will increase by $40,000 annually. The project has an economic life of 10 years. The effective tax rate for this company is 35%. There are no working capital to be liquidated, and there is no salvage value at the end of 10 years. Based on this information, the net investment of these projects is:
$87,750
Private Memorial Hotel & Spa is considering expanding its restaurant business with a 2 new restaurant in Palo Alto, California. For this purpose, they are planning to conduct a US$ 250,000 land quality survey. The new restaurants will cost US$ 3.68 million each (total = US$ 7.36 million), excluding installation costs of $263,000 per restaurant. Additionally, US$ 2 million in net working capital will be needed immediately, and the after tax salvage value of both restaurants is $0.5 million. Based on this information, the net investment of these projects is:
$9,123,000
Company xyz is considering the issuance of a 20 year bond (par value =$1,000) with an 11% coupon rate and issuance costs of $25 for each bond. Based on this information, the net present value of this bond is equal to:
$975
Sunny Pool Corporation is considering expanding its business with five new restaurants in Nevada. For this purpose, they are planning to conduct a US$ 200,000 survey to investogate potential demand for these restaurants. The new restaurants will cost US$ 1.5 million each (total = US$ 7.50 million), excluding installation costs of $300,000 per restaurant. Additionally, US$ 2 million in net working capital will be needed immediately. Based on this information, the net investment of these projects is:
$11,200,000
Poon's Noodle House is considering replacing their noodle-processing machine. The current machine was purchased 4 years ago at a total cost of $20,000. It is being depreciated straight-line to a zero value over 8 years. If Poon sells the noodle-processing machine for $13,000, what is the after-tax cash flow to Poon's Noodle House? Use 40% for the effective tax rate.
$11,800
Wiley & Jose's Corporation currently pays a $1.50 common stock dividend. Dividends are expected to grow at a 3% rate into the foreseeable future. What is the value of Wiley & Jose's common stock to an investor requiring a 14% rate of return?
$14.05
Gourrier Sleepy Motels currently pays a $2.00 common stock dividend. Dividends have been growing at a 3% annual rate and are expected to continue growing at this rate for the next 4 years. Thereafter the growth rate is expected to be 0% for the foreseeable future. What is the current value of Gourrier common stock to an investor requiring a 12% rate of return?
$18.44
An investor plans to buy a common stock and hold this for 5 years. The expected dividends are as follows: Year 1: $1.25 Year 2: $1.40 Year 3: $1.45 Year 4: $1.50 Year 5: $1.55 This investor expects to sell this stock for $45 at the end of 5 years. The investor requires a return rate of 25%. Based on this information, the present value of the common stock today is equal to:
$18.51
Spencers Majestic Foods is considering the replacement of some old equipment. The new equipment will cost $300,000 including delivery and installation. The old equipment to be replaced has a book value of $100,000 and can be sold pre-tax for $120,000. If the firm's effective tax rate is 40%, compute the net investment.
$188,000
Royal View Resort has recently purchased new kitchen appliances for US$ 9,750 (excluding taxes etc.). Sales taxes are 6%, to be added to the overall costs. The kitchen appliances will be depreciated in three years using the straight-line depreciation method. The hotel plans to sell these appliances for $2,000 after 3 years. The book value at the end of the third year is US$ 1,500. Based on this information, the annual depreciation of the kitchen appliances will be:
$2,945
The Atlantis Shield Resort & Spa expects a growth rate of 7% in the next two years, and a 7.9% constant years in the years thereafter. The dividend to be paid in one year (d1) amounts to $2.75. Investors require a 6% rate of return. based on this information, the dividend paid at the end of year 2 (d2) amounts to:
$2.94
A project is expected to increase a firm's sales revenue by $12,000 annually, decrease it cash expenses by $18,000 annually, and increase its depreciation by $10,000 annually. Given this information, what is the project's expected annual net cash flow? Use a 40% effective tax rate.
$22,000
The Glorious Nebula Resort & Spa expects an earnings per share of $6 in the coming years. The company's officials do not expect growth in their dividend in the future, and the company pays out 75% of the earnings per share. The investor requires a return rate of 20%. Based on this information, the value of the common stock in the Lord's Treasure Hotel is equal to:
$22.50
A project is expected to increase a firm's sales revenue by $50,000 annually, increase it cash expenses by $20,000 annually, and increase its depreciation by $15,000 annually. Given this information, what is the project's expected annual net cash flow? Use a 40% effective tax rate.
$24,000 *net cash flow* (Ch 9)
Keong is considering an investment in Leong's Bar & Grille Corporation. Keong is planning to buy the stock today, hold it for 2 years, and then expects to sell the stock for $30 at the end of 2 years. Keong expects the first dividend to be $1.00 and the second dividend to be $1.30. If Keong requires a 15% rate of return, what is the value of Leong's Bar & Grille common stock to Keong today?
$24.54 *Dividend Valuation Model*
An investor plans to buy a common stock and hold this for 5 years. The expected dividends are as follows: Year 1: $1.55 Year 2: $1.50 Year 3: $1.40 Year 4: $1.45 Year 5: $1.55 This investor expects to sell this stock for $50 at the end of 5 years. The investor requires a return rate of 20%. Based on this information, the present value of the common stock today is equal to:
$24.56
The Saffron Petal Hotel expect an earnings per share of $9 in the coming year. Investors require a 19% required rate of return. The Saffron Petal Hotel expects to grow in the future at 7% and, therefore, wants to retain 60% of its future earnings (this retention will remain constant in the future). These earnings can be reinvested, bearing 17 percent return on equity (this expected return on equity will remain unchanged in the future). Based on this information, the value of the common stock of the Saffron Petal Hotel is equal to:
$30
Jose's Cantinas Incorporated plans to expand. This will require the acquisition of new equipment. The equipment will cost $85,000 including delivery and installation. Additional net working capital of $25,000 will be needed immediately. Land for the expansion cost Jose's $100,000 three years ago, but could be sold to net $200,000 after taxes today. Compute the net investment for this project.
$310,000
Casey's Sports Books currently pays a $2.30 common stock dividend. Dividends have been recently growing at a 12% annual rate and are expected to continue growing at this rate for the next 3 years. Thereafter the growth rate is expected to be 5% for the foreseeable future. What is the current value of Casey's common stock to an investor requiring an 14% rate of return?
$32.11
A project is expected to decrease a firm's cash expenses by $40,000 annually, and increase its depreciation by $25,000 annually. Given this information, what is the project's expected annual net cash flow? Use a 40% effective tax rate.
$34,000
__________ represents the long-term or permanent sources of the firm's financing.
Capital structure
Which of the following is a basic principle when estimating a project's cash flows?
Cash flows should be measured on an incremental basis.
If a corporation has two classes of common stock, what is typically unique about the second or class B common stock?
Class B common stock has superior voting power. Dividends remain the same.
Why do investors require a higher expected rate of return on common stock than on bonds?
Common stock is a riskier investment
Company A is considering the issuance of a preferred stock at $200 market price. This preferred stock pays a fixed 6% dividend and there is an issuance cost of $6 per share. The par value is $100. The company expects to call the preferred stocks at $160 in 10 years. Based on this information, the cost of raising capital with preferred stocks is:
13.44% (NO)
Shamas Famous Restaurants expects to pay a common stock dividend of $1.50 per share next year (d1). Dividends are expected to grow at a 4% rate for the foreseeable future. Shamas' common stock is selling for $18.50 per share and issuance costs are $3.50 per share. What is Shamas cost of external equity?
14.00%
Company A's beta is estimated at 1.96. Its expected risk-free rate of return is 5% and the expected market return is 12%. Based on this information, the cost of internal equity financing is:
18.72%
Company A is considering the issuance of a preferred stock at $275 market price. This preferred stock pays a fixed 11% dividend and there is an issuance cost of $17 per share. The The par value is $100. Based on this information, the cost of raising capital with preferred stocks is:
2.53% (NO)
Dou's Oriental Hotels, Incorporated sold an issue of 10-year bonds. The bonds sold at $995 each. After issuance costs, Dou's Oriental Hotels received $985 each. The maturity value is $1,000 each and the coupon rate is 7 5/8% and paid annually. What is the after-tax cost of debt for these bonds if Dou's Oriental Hotels' marginal tax rate is 40%?
4.71%
Company A is financed by four types of capital, i.e., debt, preferred stock, internal and external equity financing. The financing rates (and respective weights) are as follows: Debt: 2.35% (weight = 25%) Preferred stocks: 3.75% (weight = 30%) Internal equity: 5.75% (weight = 20%) External equity: 6.00% (weight = 25%) Based on this information, the weighted average cost of capital is:
4.94%
Tokyo Food Supplies Corporation sold an issue of 12-year bonds. The bonds sold at $980 each. After issuance costs, Tokyo Food Supplies received $975 each. The maturity value is $1,000 each and the coupon rate is 9% and paid annually. What is the after-tax cost of debt for these bonds if Tokyo Food Supplies' marginal tax rate is 40%?
5.61%
Company A is considering the issuance of a 15 year bond with a 9% coupon rate and issuance costs of $20 for each bond. The tax rate is 35%. Based on this information, the cost of debt after taxes of this bond is equal to:
6.01%
Alishas Travel Tours expects to sell a new bond issue at its par value. The coupon rate is 10 7/8%. Because issuance costs are so small, Alishas plans to ignore the impact of issuance costs on the after-tax cost. What is the after-tax cost of these bonds if Alishas' marginal tax rate is 40%?
6.53%
Company A is considering the issuance of a 15 year bond (par value = $1,000) with a 9% coupon rate and issuance costs of $20 for each bond. Based on this information, the cost of debt before taxes of this bond is equal to:
9.25%
Young's Specialized Cruises plans to issue preferred stock at a price of $25 per share. The annual dividend will be $2.18 per share and issuance costs are expected to be $2.00 per share. What is the cost of raising funds with preferred stock for Young?
9.48%
Why is external common equity capital more expensive then internal common equity capital?
Because the cost of external must take into account flotation costs, internal does not.
A capital budgeting project's sunk costs and opportunity costs are both relevant to the project investment decision.
F
A firm's weighted average cost of capital is a marginal measurement meaning it is concerned with measuring the cost of funds already raised and previously invested in the firm.
F
A firm's weighted average cost of capital is the average cost of the various short-term sources of financing employed by the firm.
F
Common stock's residual claim on assets implies owners have a prior claim on assets before other claim holders are paid.
F
If a depreciable asset is sold for less than its book value, then taxes must be paid on the difference.
F
If a project is to be 100% financed with debt, then the cost of debt—not the weighted average cost of capital—should be used to evaluate the project.
F
In capital budgeting, the cost of starting a project is called the annual net cash flow.
F
Indirect cash flows caused by a capital budgeting project are not relevant to the project investment decision.
F
Issuance or flotation costs are the costs investors pay to brokers when they purchase common stock.
F
Preferred stock has higher seniority than bonds and common stock.
F
The cost of a firm's internal common equity is generally higher than the costs of a firm's external common equity due to issuance costs.
F
The lack of a fixed common stock dividend provides the corporation greater flexibility versus the use of bonds or preferred stock.
F
The most typical common stock maturity is 20 years.
F
Valuing common stock is less difficult and more precise than valuing bonds.
F
Which of the following is true for corporate stockholders?
They elect the board of directors.
The estimation of a project's net cash flows (NCF) should not include changes in
interest expense
A firm's weighted average cost of capital should not do which one of the following?
measure the cost of short-term sources of funds
Your university is considering what to do with the current football stadium. They plan to invest to upgrade the current football stadium or invest to build a new one closer to campus. What kind of projects are these?
mutually exclusive projects
The cost of external equity is greater than the cost of internal equity because
of the flotation or issuance costs
Which one of the following is not part of a project's estimated net cash flows?
the cost of a customer survey performed one year before the project decision is made
Which of the following should not be included in a firm's cost of capital estimation?
the cost of seasonal sources of short-term debt
Which one of the following is not part of the estimated net investment for a capital budgeting project?
the estimated salvage value of the new assets at the end of their 10-year expected economic life
Typically a corporation's board of directors would not make which one of the following decisions?
who can purchase the corporation's common stock
A project's net cash flows are typically cash inflows whereas a project's net investment is typically a cash outflow.
T
Common stock provides the investor a residual claim on both the firm's assets and the firm's cash flow.
T
Higher depreciation results in lower profit and higher net cash flow.
T
Investors view common stock as a riskier investment than bonds or preferred stock
T
The after-tax salvage value from replaced assets will decrease the net investment.
T
The cost of capital raised by the issuance of bonds is typically lower than the cost of capital raised from the issuance of preferred stock or common stock.
T
The valuation of common stock with zero growth is similar to the valuation of preferred stock.
T
The weights in a firm's weighted average cost of capital should be a measure of the firm's target capital structure.
T
When making a capital budgeting decision, cash flows should be estimated on an incremental basis, not a total basis.
T
Company xyz is considering the issuance of a 20 year bond (par value = $1,000) with a 11% coupon rate and issuance costs of $25 for each bond. Based on this information, the cost of debt before taxes of this bond is equal to:
11.32%
Jose's Cantinas Incorporated plans to issue preferred stock at a price of $48 per share. The annual dividend will be $5.10 per share and issuance costs are expected to be $3.00 per share. What is the cost of raising funds with preferred stock for Jose's?
11.33%
Marion's Miraculous Resorts has a current capital structure that is 50% equity, 40% debt, and 10% preferred stock. This is considered optimal. Marion is considering a $40 million capital budgeting project. Marion has estimated the following: After-tax cost of debt: 8.5% Cost of preferred stock: 9.5% Cost of internal equity: 14.0% If all equity comes from internal sources, what should Marion's cost of capital be for this project?
11.35%
Penny's Budget Gourmet Restaurants has a current capital structure that is 70% equity, 20% debt, and 10% preferred stock. This is considered optimal. Penny is considering a $100 million capital budgeting project. Penny has estimated the following: After-tax cost of debt: 7.0% Cost of preferred stock: 8.0% Cost of internal equity: 13.0% Cost of external equity: 15.0% Penny expects to have $40 million of new retained earnings available to finance this project. What is Marion's cost of capital for this project?
11.90%
Shamas Famous Restaurants expects to pay a common stock dividend of $1.50 per share next year (d1). Dividends are expected to grow at a 4% rate for the foreseeable future. Shamas' common stock is selling for $18.50 per share and issuance costs are $3.50 per share. What is Shamas cost of internal equity?
12.11%
Spencers Magic Shows Incorporated is financed 100% with equity and intends to remain this way. Spencers' common stock beta is 0.85, the expected market return (average market return) is 14%, and the risk-free rate is 6%. If all of Spencers' equity is internal, what are the cost of equity and the weighted average cost of capital for Spencers?
12.80%
Company A is considering the issuance of a preferred stock at $200 market price. This preferred stock pays a fixed 6% dividend and there is an issuance cost of $6 per share. The par value is $100. The company expects to call the preferred stocks at $160 in 10 years. Based on this information, the cost of raising capital with preferred stocks is:
13.20% (NO)
Why do a project's net cash flows not include additional interest expense?
Interest expense is taken into account by the use of a required rate of return used in the decision method.
The cost of raising capital with debt is typically less costly for a firm than raising capital with preferred stock. Which one of the following is one of the reasons for this?
Interest is a tax-deductible cost, preferred dividends are not.
Everything else being the same, the greater an investor's required rate of return, what is true of the value of common stock?
It is worth less.
Which one of the following is not a basic principle for estimating a project's net cash flows?
Sunk costs are relevant.
Which of the following is true the longer a common stock investor's expected holding period?
The investor's holding period has no impact on the current value of common stock.
Why is common stock financing lower risk to the firm than financing with bonds?
The lack of a fixed dividend provides the firm greater flexibility versus the interest cost of a bond.
Statement 1: Net investment is an element of the cost-benefit analysis, specifically the benefit component. Statement 2: Net cash flow is part of the cost-benefit analysis, specifically the cost component.
both are incorrect
Statement 1: If the Excursion Hotel & Spa has two projects competing for execution, then the capital budgeting analysis should decide which project has the highest increase in value for the firm. Statement 2: If the Citadel Resort & Spa has to decide between a hotel in Orlando or in Tampa, this is an example of a mutually exclusive decision.
both are true
Which one of the following would not typically be considered a capital budgeting project for a restaurant?
buying toilet paper for both the ladies' and men's restrooms
Which answer appropriately ranks the securities according to seniority risk, from highest risk first to lowest risk last?
common stock, preferred stock, bonds
What is net working capital?
current assets - current liabilities
What impact will an increase in depreciation have upon a firm?
decrease profit and increase cash flow
Which model is typically used to estimate the cost of using external equity capital?
dividend valuation model
Into which two parts is a firm's earnings divided?
dividends and addition to retained earnings