Question 1 through 5 use information below:

Problems 1 to 5

You are employed by ABC Inc. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT.

Assets

Current assets $30,000,000

Net plant, property, and equipment $100,000,000

Total Assets $130,000,000

Liabilities and Equity Accounts payable $10,000,000 Accruals $10,000,000

Current liabilities $20,000,000

Long term debt (40,000 bonds, $1,000 face value) $40,000,000

Total liabilities $60,000,000

Preferred Stock (100,000 shares, $100 face value) $10,000,000

Common Stock (10,000,000 shares) $30,000,000 Retained Earnings $30,000,000

Total shareholders equity $70,000,000

Total liabilities and shareholders equity $130,000,000

You check The Wall Street Journal and see that ABC stock is currently selling for $8.00 per share and that ABC bonds are selling for $950.0 per bond. These bonds have a 8 percent coupon rate, with semi-annual payments. The bonds mature in twelve years. The preferred stock has an unlimited life and pays an 6 percent annual coupon. The preferred stock sells for $95. The beta for your company is approximately equal to 2. The yield on a 20-year Treasury bond is 4.0 percent. The expected return on the stock market is 8.0 percent. ABC is in the 40 percent tax bracket.

1) WHAT IS THE FIRM'S COST OF COMMON STOCK, Ks?

10%

11%

12%

13%

14%

2) WHAT IS THE COST OF PREFERRED STOCK, Kps?

5.46%

4.89%

3.99%

6.32%

8.21%

3) WHAT IS THE AFTER-TAX COST OF DEBT, Kd?

5.21%

4.06%

7.89%

2.02%

6.77%

4) WHICH OF THE FOLLOWING IS THE BEST ESTIMATE FOR THE WEIGHTS TO BE USED WHEN CALCULATING THE WACC?

We = 0.63, Wd = 0.30, and Wps = 0.07

We = 0.68, Wd = 0.23, and Wps = 0.09

We = 0.68, Wd = 0.30, and Wps = 0.02

We = 0.66, Wd = 0.28, and Wps = 0.06

We = 0.66, Wd = 0.26, and Wps = 0.08

5) What is the best estimate of the WACC for ABC?

9.15%

9.39%

9.55%

7.65%

8.28%

Question 6

Davis Corporation is faced with two independent investment opportunities. The corporation has an investment policy which requires acceptable projects to recover all costs within 3 years. The cost of capital is 10 percent. The cash flows for the two projects are:

	Project A	Project B
Year	Cash Flow	Cash Flow
0	-120,000	-90,000
1	42,000	30,000
2	43,000	30,000
3	44,000	30,000
4	45,000	30,000
5	46,000	30,000

What is the payback period of each investment?

A = 3.8 years and B = 3.43 years

A = 2 years and B = 3 years

A = 2.8 years and B = 2.43 years

A = 2.8 years and B = 3 years

A = 2.2 years and B = 3.3 years

Question 7

What is the discounted payback period of each investment?

3.03 years and 3.75 years

4.43 years and 2.75 years

3.43 years and 4.75 years

4.43 years and 3.75 years

3.43 years and 3.75 years

Question 8

What is the NPV of each investments?

$42,075 and $23,024

$46,075 and $23,724

$26,075 and $43,724

$46,075 and $26,724

$42,075 and $23,724

Question 9

XYZ Corporation is faced with two mutually exclusive investment opportunities. The cost of capital is 12 percent. The cash flows for the two projects are:

	Project A	Project B
Year	Cash Flow	Cash Flow
0	-140,000	-100,000
1	60,000	30,000
2	60,000	30,000
3	60,000	30,000
4		30,000
5		30,000
6		30,000

What is the Equivalent Annual Annuity (EAA) for each investments?

$1,711 and $4,677

$1,311 and $5,377

$5,677 and $1,711

$2,711 and $5,677

$1,711 and $5,677

Question 10

XYZ Corporation is faced with two mutually exclusive investment opportunities. The cost of capital is 12 percent. The cash flows for the two projects are:

	Project A	Project B
Year	Cash Flow	Cash Flow
0	-140,000	-100,000
1	60,000	30,000
2	60,000	30,000
3	60,000	30,000
4		30,000
5		30,000
6		30,000

What is the NPV for each investments UNDER THE REPLACEMENT APPROACH?

$8,035 and $23,342

$7,035 and $23,342

$7,135 and $23,342

$7,035 and $23,142

$7,035 and $24,342