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essentials of management
Essentials Of Financial Management 4th Edition Eugene F. Brigham, Joel F. Houston, Jun-Ming Hsu, Yoon Kee Koong, A. N. Bany-Ariffin - Solutions
12.8 Project X is very risky and has an NPV of 53 million. Project Y is very safe and has an NPV of $2.5 million. They are mutually exclusive, and project risk has been properly considered in the NPV analyses. Which project should be chosen? Explain.
12.7 Why might it be rational for a small firm that does not have access to the capital markets to use the payback method rather than the NPV method?
12.6 Discuss the following statement: If a firm has only independent projects, a constant WACC, and projects with normal cash flows, the NPV and IRR methods will always lead to identical capital budgeting decisions.What does this imply about the choice between IRR and NPV? If each of the
12.5 If two mutually exclusive projects were being compared, would a high cost of capital favour the longer-term or the shorter-term project? Why?If the cost of capital declined, would that lead firms to invest more in longer-term projects or shorter-term projects? Would a decline (or an increase)
12.4 What is a mutually exclusive project? How should managers rank mutu-ally exclusive projects?
12.3 Why is the NPV of a relatively long-term project (one for which a high percentage of its cash flows occurs in the distant future) more sensitive to changes in the WACC than that of a short-term project?
12.2 What are three potential flaws with the regular payback method? Does the discounted payback method correct all three flaws? Explain.
12.1 How are project classifications used in the capital budgeting process?
ST-2 CAPITAL BUDGETING CRITERIA You must analyze two projects, X and Y.Each project costs $10,000, and the firm's WACC is 12%. The expected cash flows are as follows:0 12 34 Project X-$10,000$6,500$3,000$3,000$1,000 Project Y$10,000$3,500$3,500$3,500$3,500 a.Calculate each project's NPV, IRR. MIRR,
ST-1 KEY TERMS Define the following terms:a. Capital budgeting; strategic business planb. Net present value (NPV)c. Internal rate of return (IRR)d. NPV profile; crossover ratee. Mutually exclusive projects; independent projectsf. Nonnormal cash flows; normal cash flows; multiple IRRs g- Modified
11-21 CALCULATING THE WACC Here is the condensed 2015 balance sheet for Skye Computer Company (in thousands of dollars):Skye's earnings per share last year were $3.20. The common stock sells for $55.00, last year's dividend (D) was $2.10, and a flotation cost of 10% would be required to sell new
11-20 WACC The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 7.8 million shares outstanding, is now (1/1/16) selling for $65.00 per share. The expected dividend at the end of the current year (12/31/16) is 55% of the 2015 EPS, Because inves-tors
11-19 ADJUSTING COST OF CAPITAL FOR RISK Ziege Systems is considering the following independent projects for the coming year:Ziege's WACC is 10%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects.a. Which projects should Ziege accept if
11-18 WACC AND OPTIMAL CAPITAL BUDGET Adams Corporation is consid-ering four average-risk projects with the following costs and rates of return:The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of
11-17 CALCULATION OF g AND EPS Sidman Products's common stock currently sells for $60.00 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60, and it finances only with common equity.a. If investors require a 9% return, what is the expected growth
11-16 COST OF COMMON EQUITY The Bouchard Company's EPS was $6.50 in 2015, up from $4.42 in 2010. The company pays out 40% of its earnings as dividends, and its common stock sells for $36.00.a. Calculate the past growth rate in earnings. (Hint: This is a 5-year growth period.)b.The last dividend was
11-15 WACC AND COST OF COMMON EQUITY Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 13%, a before-tax cost of debt of 10%, and a tax rate of 40%. The company's retained earn-ings are
11-14 COST OF PREFERRED STOCK INCLUDING FLOTATION Trivoli Industries plans to issue perpetual preferred stock with an $11.00 dividend. The stock is currently selling for $97.00, but flotation costs will be 5% of the market price, so the net price will be 592.15 per share. What is the cost of the
11-13 COST OF COMMON EQUITY WITH FLOTATION Ballack Co.'s common stock currently sells for $46.75 per share. The growth rate is a constant 12%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio is 25%, and the expected return on equity(ROE) is 16%. New
11-12 WACC Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of r. = 10%as long as it finances at its target capital structure, which calls for 45%debt and 55% common equity. Its last dividend (D) was $2, its expected constant
11-11 WACC AND PERCENTAGE OF DEBT FINANCING Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at r. = 11%, and its common stock currently pays a $2.00 dividend per share(D) = $2.00). The stock's price is currently $24.75, its dividend is expected to
11.10 WACC Klose Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%, Klose must raise additional capital to fund its upcoming expansion. The firm will have $2 million of retained earnings with a cost of r. = 12%.New common
11-9 WACC The Patrick Company's year-end balance sheet is shown below. Its cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm's total debt, which is the sum of the company's
11-8 COST OF COMMON EQUITY AND WACC Patton Paints Corporation has a target capital structure of 40% debt and 60% common equity, with no preferred stock. Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. The current stock price is P. = $22.50. The last dividend was D. =$2.00, and
11-7 COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION The Evanec Company's next expected dividend, D ., is $3.18; its growth rate is 6%; and its common stock now sells for $36.00. New stock (external equity) can be sold to net $32.40 per share.a. What is Evanec's cost of retained earnings, r .?b.
11-6 COST OF COMMON EQUITY The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 7% per year. Carpetto's common stock currently sells for $23.00 per share; its last dividend was $2.00; and it will pay a 52.14 dividend at the end of the current
11-5 PROJECT SELECTION Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects:Assume that each of these projects is just as risky as the firm's existing assets and that the firm may accept all the projects or only some of them.Which
11-4 COST OF EQUITY WITH AND WITHOUT FLOTATION Javits & Sons's common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $3.00 a share at the end of the year (D, = $3.00), and the constant growth rate is 5% a year.a.What is the company's cost of common equity if
11-3 COST OF COMMON EQUITY Percy Motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 9%, and its tax rate is 40%. Percy's CFO estimates that the company's WACC is 9.96%. What is Percy's cost of
11-2 COST OF PREFERRED STOCK Tunney Industries can issue perpetual preferred stock at a price of $47.50 a share. The stock would pay a constant annual dividend of $3.80 a share. What is the company's cost of preferred stock, r .?
11-1 AFTER-TAX COST OF DEBT The Heuser Company's currently outstanding bonds have a 10% coupon and a 12% yield to maturity. Heuser believes it could issue new bonds at par that would provide a similar yield to matu-rity. If its marginal tax rate is 35%, what is Heuser's after-tax cost of debt?
11-5 TheWACC is a weighted average of the costs of debt, preferred stock, and common equity. Would the WACC be different if the equity for the coming year came solely in the form of retained earnings versus some equity from the sale of new common stock? Would the calculated WACC depend in any way
11-4 Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be "reasonable" costs of capital for average -, high -, and low-risk projects?
11-3 How should the capital structure weights used to calculate the WACC be determined?
11-2 Assume that the risk-free rate increases, but the market risk premium remains constant. What impact would this have on the cost of debt? What impact would it have on the cost of equity?
11-1 How would each of the following scenarios affect a firm's cost of debt, r(1-T); its cost of equity, r; and its WACC? Indicate with a plus (+), a minus (-), or a zero (0) whether the factor would raise, lower, or have an indeterminate effect on the item in question. Assume for each answer that
ST-2 WACC Lancaster Engineering Inc. (LEI) has the following capital struc-ture, which it considers to be optimal:Debt 25%Preferred stock 15 Common equity 60 100%LEI's expected net income this year is $34,285.72; its established dividend payout ratio is 30%; its federal-plus-state tax rate is 40%;
ST-1 KEY TERMS Define each of the following terms:a. Target capital structure; capital componentsb. Before-tax cost of debt, r . after-tax cost of debt, r.(1-T)c. Cost of preferred stock, r.d. Cost of retained earnings, ry; cost of new common stock, r.e. Weighted average cost of capital, WACC f."
Should all divisions within the same firm use the firm's composite WACC for evaluating all capital budgeting projects? Explain.
How should firms evaluate projects with different risks?
Why is the cost of capital sometimes referred to as a "hurdle rate"?
Firm A has 11 equally risky capital budgeting projects, each costing $19,608 million and each having an expected rate of return of 8.25%. Firm A's retained earnings breakpoint is $196.08 million. The firm's WACC using retained earnings is 8.0% but increases to 8.5% if new equity must be issued. The
What is Firm A's WACC if it issues new common stock? (8.53%)
Firm A has the following data: Target capital structure of 46% debt, 3% preferred, and 51% common equity; Tax rate=40%; -7%; r = 7.5%; r = 11.5%; and r=12.5%. What is the firm's WACC if it does not issue any new stock? (8.02%)
Write the equation for the WACC.
Suppose Firm A plans to retain $100 million of earnings for the year. It wants to finance its capital budget using a target capital structure of 46% debt, 3% preferred, and 51% common equity. How large could its capital budget be before it must issue new common stock? ($196.08 million)
A firm's common stock has D, = $1.50, P = $30.00, g = 5%, and F = 4%. If the firm must issue new stock, what is its cost of new external equity? (10.21%)
Would a firm that has many good investment opportunities be likely to have a higher or a lower dividend payout ratio than a firm with few good investment opportunities? Explain.
What are the two approaches that can be used to adjust for flotation costs?
Suppose you are an analyst with the following data: -5.5%, -=6%, b=0.8, D, $1.00, P = $25.00, g=6%, and r = firm's bond yield = 6.5%. What is this firm's cost of equity using the CAPM, DCF, and bond-yield-plus-risk- premium approaches? Use the midrange of the judgmental risk premium for the
What's the logic behind the bond-yield-plus-risk-premium approach?
Which of the two components of the DCF formula, the dividend yield or the growth rate, do you think is more difficult to estimate? Why?
Identify some potential problems with the CAPM.
What three approaches are used to estimate the cost of common equity? Which approach is most commonly used in practice?
Why must a cost be assigned to retained earnings?
A company has outstanding 20-year noncallable bonds with a face value of $1,000, an 11% annual coupon, and a market price of $1,294.54. If the company was to issue new debt, what would be a reasonable estimate of the interest rate on that debt? If the company's tax rate is 40%, what is its
How can the yield to maturity on a firm's outstanding debt be used to estimate its before-tax cost of debt?
Why is the relevant cost of debt the interest rate on new debt, not that on already outstanding, or old, debt?
Why is the after-tax cost of debt rather than the before-tax cost used to calculate the WACC?
10A-3 BETA COEFFICIENTS Suppose Chance Chemical Company's management conducted a study and concluded that if it expands its consumer products division (which is less risky than its primary business, industrial chem- icals), its beta will decline from 1.2 to 0.9. However, consumer products have a
10A-2 EQUILIBRIUM STOCK PRICE The risk-free rate of return, ry, is 6%; the required rate of return on the market, r ., is 10%; and Upton Company's stock has a beta coefficient of 1.5.a. If the dividend expected during the coming year, D ,, is $2.25 and if g = a constant 5%, at what price should
10A-1 RATES OF RETURN AND EQUILIBRIUM Stock C's beta coefficient is b =0.4, and Stock D's is by = 0.5. (Stock D's beta is negative, indicating that its return rises when returns on most other stocks fall. There are very few negative beta stocks, although collection agency stocks are sometimes cited
10A-2 If a stock is not in equilibrium, explain how financial markets adjust to bring it into equilibrium.
10A-1 For a stock to be in equilibrium, what two conditions must hold?
10-22 NONCONSTANT GROWTH AND CORPORATE VALUATION Rework problem 10-18, partsa, b, andc, using a spreadsheet model. For partb, calculate the price, dividend yield, and capital gains yield as called for in the problem.After completing parts a throughc, answer the following additional ques-tion, using
10-21 NONCONSTANT GROWTH Assume that it is now January 1, 2016.Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the
10-20 CORPORATE VALUE MODEL Assume that today is December 31, 2015, and that the following information applies to Vermeil Airlines: After-tax operating income [EBIT (1-T)] for 2016 is expected to be $500 million. The depreciation expense for 2016 is expected to be $100 million. The capital
10-19 CORPORATE VALUATION Barrett Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings.In other words, Barrett does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing
10-18 NONCONSTANT GROWTH STOCK VALUATION Taussig Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth rate is expected to last for another 2 years, then decline to g. = 6%.a. If D = $1.60 and r. = 10%, what is ITC's stock worth today? What are
9-17 CONSTANT GROWTH Your broker offers to sell you some shares of Bahnsen & Co. common stock that paid a dividend of $2.00 yesterday. Bahnsen's dividend is expected to grow at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3 years and then sell it. The appropriate
10-16 NONCONSTANT GROWTH Gigabyte Co. is expected to grow fast in the following 2 years and the growth rate is 20%. Gigabyte will return to its normal growth rate g constantly hereafter. The current stock price is $50 and the company just paid $1.50 dividend this year. The required rate of return
10-15 CORPORATE VALUATION Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs)during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier's WACC is 13%.Year 23 FCF (S millions)-$20$30$40 a.What is
10-14 NONCONSTANT GROWTH Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech to begin paying divi-dends, beginning with a dividend of $1.00 coming 3 years from today. The dividend should
10-13 CONSTANT GROWTH Quanta Inc. has a beta of 1.5. The market risk premium is 7% and the risk-free rate is 3%. Assuming that the market is in equilibrium and the stock currently sells for $30 a share, Quanta just paid $2 dividend this year and the dividend is expected to grow at a constant rate
10-12 VALUATION OF A CONSTANT GROWTH STOCK Investors require a 15% rate of return on Levine Company's stock (i.e., r = 15%).a. What is its value if the previous dividend was D, = $2 and investors expect dividends to grow at a constant annual rate of (1) - 5%, (2) 0%, (3) 5%, or (4) 10% ?b. Using
10-11 VALUATION OF A CONSTANT GROWTH STOCK A stock is expected to pay a dividend of 50.50 at the end of the year (i.e ., D = 0,50), and it should continue to grow at a constant rate of 7% a year. If its required return is 12%, what is the stock's expected price 4 years from today?
10-10 VALUATION OF A DECLINING GROWTH STOCK Martell Mining Company's ore reserves are being depleted, so its sales are falling. Also, because its pit is getting deeper each year, its costs are rising. As a result, the company's earnings and dividends are declining at the constant rate of 5% per
10-9 PREFERRED STOCK RETURNS Largan Co. has a preferred stock outstanding with a par value of $100 and its dividend is $1 per quarter.The current stock price is $120. What is its nominal required rate of return per annual? What is the effective rate of return?
10-8 PREFERRED STOCK VALUATION Ezzell Corporation issued perpetual preferred stock with a 10% annual dividend. The stock currently yields 8%, and its par value is $100.a. What is the stock's value?b. Suppose interest rates rise and pull the preferred stock's yield up to 12%. What is its new market
10-7 PREFERRED STOCK VALUATION Hon-Hai Inc. issues preferred stock with par value of $100 and a stated dividend of 6% of par. Assuming that Hon-Hai's preferred stockholders require a return of 10%, what is the current market price of the stock?
10-6 PREFERRED STOCK VALUATION Foxconn Corp. has preferred stock outstanding that sells for $50 a share and pays a dividend of $4 at the end of each year. What is the required rate of return for preferred stockholders?
10-5 CORPORATE VALUATION Micro-Star Co. has 100 million shares of stock outstanding and its WACC is 12%. Micro-Star is expected to generate S200 million in free cash flow next year, and the cash flow is expected to grow at a constant rate of 6% per year indefinitely. Micro-Star is an all equity
10-4 NONCONSTANT GROWTH VALUATION Hart Enterprises recently paid a dividend, D ., of $1.25. It expects to have nonconstant growth of 20% for 2 years followed by a constant rate of 5% thereafter. The firm's required return is 10%.a. How far away is the horizon date?b. What is the firm's horizon, or
10-3 CONSTANT GROWTH VALUATION The required rate of return on Wistron Inc.'s stock is 15% and it just paid a dividend of $1.50 a share. The stock currently sells for $25.00 a share. Assuming that the dividend grows consistently at a fixed growth rate, what is the growth rate? What stock price is
10-2 CONSTANT GROWTH VALUATION Thomas Brothers is expected to pay a$0.50 per share dividend at the end of the year (i.e ., D. = $0.50). The divi-dend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, r , is 15%. What is the stock's current value per
10-1 DPS CALCULATION Miller Inc. plans to pay dividend of $1.20 a share this year and the dividend is expected to grow 10% a year for the next 2 years due to the promotion of new products. Thereafter, the dividend will return back to the normal level of 5% a year. What is the expected dividend per
10-7 This chapter discusses the discounted dividend and corporate valuation models for valuing common stocks. Two alternative approaches, the P/E multiple and EVA approaches, were presented. Explain each approach and how you might use each one to value a common stock.
10-6 Discuss the circumstances that are good for using the discounted divi-dend model and the corporate valuation model.
10-5 A bond that pays interest forever and has no maturity is a perpetual bond.In what respect is a perpetual bond similar to a no-growth common stock?Are there preferred stocks that are evaluated similarly to perpetual bonds and other preferred issues that are more like bonds with finite
10-4 Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of D, and on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10
10-3 The investment return of an individual stock can comprise dividend yield and eventual capital gain. Suppose there are two stocks: one stock with dividend payment and the other that does not pay any dividend. Is it possible that both stocks have the same investment returns? Explain.
10-2 Is the following equation correct for finding the value of a constant growth stock? Explain.P-D.I + g
10-1 It is frequently stated that the one purpose of the preemptive right is to allow individuals to maintain their proportionate share of the ownership and control of a corporation.a. How important do you suppose control is for the average stockholder of a firm whose shares are traded on the New
ST-4 NONCONSTANT GROWTH STOCK VALUATION Snyder Computers Inc. is experiencing rapid growth. Earnings and dividends are expected to grow at a rate of 15% during the next 2 years, at 13% the following year, and at a constant rate of 6% during Year 4 and thereafter. Its last dividend was$1.15, and its
ST-3 CONSTANT GROWTH STOCK VALUATION Fletcher Company's current stock price is $36.00, its last dividend was $2.40, and its required rate of return is 12%. If dividends are expected to grow at a constant rate, g, in the future and if r is expected to remain at 12%, what is Fletcher's expected stock
ST-2 STOCK GROWTH RATES AND VALUATION You are considering buying the stocks of two companies that operate in the same industry. They have very similar characteristics except for their dividend payout policies. Both companies are expected to earn $3 per share this year, but Company D (for"dividend")
ST-1 KEY TERMS Define the following terms:a. Proxy; proxy fight; takeoverb. Preemptive rightc. Classified stock; founders' sharesd. Marginal investor; intrinsic value (P); market price (P)e. Required rate of return, r; expected rate of return, f; actual (realized) rate of return,f. Capital gains
Is the equation used to value preferred stock more like the one used to value a bond or the one used to value a "normal" constant growth common stock? Explain.
Explain the following statement: Preferred stock is a hybrid security.
Why might the calculated intrinsic value differ from the stock's current market price? Which would be "correct" and what does "correct" mean?
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