2You are considering opening a premium lemonade stand on the corner of Main and Anywhere Street in your hometown.

You have determined that you will need $1,025 to buy equipment, a table, two chairs and other sundry items to get started. Youll also need $250 in the bank to make change with customers and purchase lemonade drink mix in a variety of flavours, including traditional lemonade, strawberry, cherry and grape flavours. Each cup of lemonade that you sell will be priced at $9.99 (after all this lemonade is made from your grandmothers secret recipe).

Sales in year 1 are estimated to be 100 cups, and you predict that sales will rise by 20% annually between in years 2 and 5. Direct materials costs are estimated to be 50% of annual sales and direct labour costs 20% of annual sales.

Fixed preparation costs will be $250 annually.

You are financing the business with a single $500 par value bond issued to your parents at a price of 135. The bond has a 10% coupon rate, and a term of 5 years. You have also issued 600 common shares to other family members at a price of $1 per share.

You recently read in the Times of Anywhere (a local newspaper) that risk free investments are offering an 8% return, and that the beta on lemonade stands is .80. The expected return in the premium lemonade market is 10%.

You have also confirmed with your accounting professor that the companys tax rate will be 10%, and the depreciation rate on lemonade stands is 15%.

Finally, your research has also determined that lemonade stands are predicted to have a perpetual growth rate of 2% after the first five years of operation.

1.

A

Your parents paid you $_____ cash for the bond you issued to them.

1. $675
2. $500
3. $375
4. $100

Answer:

B

The after-tax cost (after-tax interest rate) of the bond that you issued to your parents is _____%.

1. 10.50%
2. 9.60%
3. 2.26%
4. 2.51%

Answer:

C

What is your lemonade stands weighted average cost of capital (WACC)?

1. 2.00%
2. 6.00%
3. 5.71%
4. 2.51%

Answer:

D

Based on the beta for your lemonade stand, your new business has ___________ compared to the market.

1. More risk
2. Less risk
3. The same risk

Answer: