1 The corporate treasurer of Ajax Company expects the company to grow at 4% in the future,...
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1 | The corporate treasurer of Ajax Company expects the company to grow at 4% in the future, and debt securities | |||||
at 6% interest (tax rate = 30%) to be a cheaper option to finance the growth. The current market price per share | ||||||
of its common stock is $39, and the expected dividend in one year is $1.50 per share. Calculate the cost of the company's | ||||||
retained earnings and check if the treasurer's assumption is correct. | ||||||
Answer: | Cost of debt after tax is | 4.20% | ||||
Cost of retained earnings is | 7.85% | |||||
2 | The risk-free rate on 10-year U.S. Treasury bills is 3% and the expected rate of return on the overall stock market is 11%. | |||||
The company has a beta of 1.6. What is the cost of equity? | ||||||
Answer: | The cost of equity is | 15.80% | ||||
3 | A company has a capital structure as follows: | |||||
Total Assets | $600,000 | |||||
Debt | $300,000 | |||||
Preferred Stock | $100,000 | |||||
Common Equity | $200,000 | |||||
What would be the minimum expected return from a new capital investment project to satisfy the suppliers of the capital? | ||||||
Assume the applicable tax rate is 40%, interest on debt is 11%, flotation cost per share of preferred stock is $0.75, and | ||||||
flotation cost per share of common stock is $4. The preferred and common stocks are selling in the market for $26 and $143 | ||||||
a share respectively, and they are expected to pay a dividend of $2 and $7, repectively,in one year. The company's dividends | ||||||
are expected to grow at 13% per year. The firm would like to maintain the existing capital structure to finance the new | ||||||
project. | ||||||
Answer: | The minimum expected return from a new capital investment project is the WACC plus any additional risk premium. | |||||
Since no additional risk is mentioned, we will use the WACC. | ||||||
Cost of debt after tax is | 6.60% | |||||
Cost of preferred stock is | 7.92% | |||||
Cost of common stock is | 18.04% | |||||
WACC is | 10.63% | |||||
4 | Required rate of return is 10%. | |||||
Net Cash Flow | ||||||
Year | Project A | Project B | ||||
0 | -$2,000 | -$2,500 | ||||
1 | $900 | $1,500 | ||||
2 | $1,100 | $1,300 | ||||
3 | $1,300 | $800 | ||||
a) | Calculate the payback period for each project. | |||||
Project A | Project B | |||||
Answer: | 2.00 | 1.77 | Payback Period in years. | |||
b) | Calculate the net present value for each project. | |||||
Project A | Project B | |||||
Answer: | $703.98 | $539.07 | ||||
c) | Which project do you think will be approved, if only one project can be approved? Why? | |||||
Project A | Project B | |||||
Answer: | Yes | No | ||||
d) | What if the required rate of return was 20%? | |||||
Answer: | Project A | Project B | ||||
$266.20 | $115.74 | Net Present Value | ||||
Yes | No | |||||
5 | A corporate bond has a face value of $1,000 and an annual coupon interest rate of 7%. Interest is paid annually. | |||||
10 years of the life of the bond remain. The current market price of the bond is $872. To the nearest whole percent, | ||||||
what is the yield to maturity (YTM) of the bond today? | ||||||
Answer: | 9% | |||||
6 | Ajax Manufacturing is expected to pay a dividend of $8 per share next year. The dividend growth rate is expected to continue to be 3%. | |||||
Required rate of return is 14%. | ||||||
a) | What should be the current market price per share? | |||||
Answer: | $72.73 | |||||
b) | What is the annual rate of return if you purchase the stock at $65? | |||||
Answer: | 15.31% | |||||
7 | A common stock sells for $82 per share, has a growth rate of 7% and a dividend that was just paid of $3.82. What is the | |||||
annual percent yield per share? | ||||||
D0 = $3.82 and therefore D1 = $3.82 x 1.07 = | $4.09 | |||||
Answer: | 11.98% | |||||
8 | A corporate bond has a face value of $1,000 and an annual coupon interest rate of 6%. Interest is paid annually. | |||||
12 years of the life of the bond remain. The current market price of the bond is $1,027, and it will mature at $1,100. | ||||||
To the nearest whole percent, what is the yield to maturity (YTM) of the bond today? | ||||||
Answer: | 6% |
Related Book For
Foundations of Finance
ISBN: 978-0134084015
9th edition
Authors: Arthur J. Keown, John H. Martin, J. William Petty
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