Question 1 Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following

data: D0 = $0.90; P0 = $30.00; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? 9.60% 11.33% 8.37% 10.21%

Question 2 Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50),

the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity.

What is the company’s WACC if all the equity used is from retained earnings?

7.07% 7.36% 7.67% 7.98% 8.29%

Question 3 Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback? WACC: 10.00%

Year 0 1 2 3 4 Cash flows -$950 $525 $485 $445 $405

1.61 years 1.79 years 1.99 years 2.22 years 2.44 years 5 points

Question 4 Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual

coupon that is paid semiannually. The bond currently sells for $950, and the company’s tax rate is 40%. What is the component cost of debt for use in the WACC calculation? 4.81% 4.49% 4.31% 5.48% 5.30%

Question 5 Lasik Vision Inc. recently analyzed the project

whose cash flows are shown below. However, before Lasik decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much

did the change in the WACC affect the project’s forecasted NPV? Note that a project’s projected NPV can be negative, in which case it should be rejected. Old WACC: 8.00% New WACC 8.50% Year 0 1 2 3 Cash flows -$1,000 $410 $410 $410

-$8.99 -$9.27 -$9.46 -$10.88 -$11.83

Question 6 Last month, Lloyd’s Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project took place, the Federal Reserve changed interest rates and therefore the firm’s WACC. The Fed’s

action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV? Note that a project’s expected NPV can be negative, in which case it should be rejected. Old WACC: 10.00% New WACC: 11.25% Year 0 1

2 3 Cash flows -$1,000 $410 $410 $410 -$18.89 -$19.88 -$20.93 -$22.03 -$23.13

Question 7 Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback? WACC: 10.00% Year 0 1 2 3 Cash flows

-$650 $500 $500 $500 1.75years 1.83years 1.81years 1.47years 1.56years

Question 8 To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid

semiannually, sells at a price of $875, and has a par value of $1,000. If the firm’s tax rate is 40%, what is the component cost of debt for use in the WACC calculation? 5.95% 5.63% 6.47% 6.15% 5.31%

Question 9 Fernando Designs is considering a project that

has the following cash flow and WACC data. What is the project’s discounted payback? WACC: 10.00% Year 0 1 2 3 Cash flows -$900 $500 $500 $500 $500 1.88 years 2.09 years 2.29 years 2.52 years 2.78 years

Question 10 Stern Associates is considering a project

that has the following cash flow data. What is the project’s payback? Year 0 1 2 3 4 5 Cash flows -$950 $300 $310 $320 $330 $340 3.06 years 3.24 years 2.97 years 3.70 years 3.49 years

Question 11 Ingram Electric Products is considering a project that has the

following cash flow and WACC data. What is the project’s MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: 9.50% Year 0 1 2 3 Cash flows -$800 $350 $350 $350 15.03% 13.73% 10.88%

12.95% 10.62%

Question 12 Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback? WACC: 10.00% Year 0 1 2 3 Cash flows -$950 $500 $500 $500 2.22years 2.04years 2.75years 1.69years

2.35years

Question 13

Ingram Electric Products is considering a project that has the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less than the WACC (and even negative), in which case it will be rejected.

Old WACC: 11.00%

Year 0 1 2 3

Cash flows -$800 $350 $350 $350

8.86%

9.84%

10.94%

12.15%

13.50%

Question 14

Last month, Lloyd’s Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV? Note that a project’s projected NPV can be negative, in which case it should be rejected.

Old WACC: 10.00% New WACC 13.50%

Year 0 1 2 3

Cash flows -$1,000 $410 $410 $410

-$64.47

-$46.56

-$59.70

-$61.49

-$54.32

5 points

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what’s the chosen NPV versus the maximum possible NPV? Note that (1) “true value” is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.

WACC 8.50%

0 1 2 3 4

CFS -$1,100 $550 $600 $100 $100

CFL -$2,700 $650 $725 $800 $1,400

$84.43

$75.14

$79.36

$102.16

$105.54

Question 16

To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm’s tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

4.35% 4.58% 4.83% 5.08% 5.33%

Question 17

S. Bouchard and Company hired you as a consultant to help estimate its cost of common equity. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

-1.49%

-1.66%

-1.84%

-2.03%

-2.23%

Question 18

Last month, Lloyd’s Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV? Note that a project’s projected NPV can be negative, in which case it should be rejected.

Old WACC: 10.00% New WACC 12.50%

Year 0 1 2 3

Cash flows -$1,000 $410 $410 $410

-$43.26

-$39.80

-$48.02

-$47.15

-$44.12

Question 19

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $25.00; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?

12.26%

10.85%

13.24%

12.37%

11.72%

Question 20

Rivoli Inc. hired you as a consultant to help estimate its cost of common equity. You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of common from retained earnings?

10.69%

11.25%

11.84%

12.43%

13.05%

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