Question: (a) A firm with a return on common equity (ROCE) of 25% has financial leverage of 35 % and a net after-tax borrowing cost of

(a) A firm with a return on common equity (ROCE) of 25% has financial leverage of 35 % and a net after-tax borrowing cost of 5% on $220 millions of net debt. What rate of return does this firm earn on its operations (RNOA)? (4 marks) (b) The firm is considering repurchasing $170 million of its stock and financing the repurchase with further borrowing at a 5% after-tax borrowing cost. What effect will this transaction have on the firm's return on common equity if the same level of operating profitability is maintained? (6 marks) (c )Will the normal P/E ratio for this firm change because of this transaction? Why? (3 marks) (d )What explanation would you give for the drop in stock price on an earnings increase? (4 marks) (e ) What is default premium? (3 marks) (f ) Why are growth stock often seen as high risk?

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=+d. Draw the net present value profiles for each store on the same set of axes, and discuss any conflict in ranking that may exist between NPV and IRR.

=+c. What does your answer to part b tell you about this projects IRR?