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FIN515/FIN 515 WEEK 6 EXAM SET 1

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FIN 515 WEEK 6 10. Question : (TCO H) Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a three-year tax life, would be depreciated by the straight-line method over its three-year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s three-year life. What is the project’s NPV? Risk-adjusted WACC Net investment cost (depreciable basis) Straight-line deprec. rate Sales revenues, each year Operating costs (excl. deprec.), each year Tax rate 10.0% $65,000 33.333% $65,500 $25,000 35.0% a. $15,740 b. $16,569 c. $17,441 d. $18,359 e. $19,325 Indicate your choice for your answer – a,b,c,d,e first and then show your work/explain your answer so as to earn partial credit in the event you selected the incorrect answer. 1. (TCO D) A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors’ required rate of return is 11.4%, what is the stock price? 2. (TCO D) If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock’s expected total return for the coming year? (Points : 10) 3. (TCO D) Rebello’s preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return? (Points : 10) 6.62% 4. (TCO E) Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? (Points : 10) 5. (TCO E) Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A’s cost of capital is 10.0%, Division B’s cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A’s projects are equally risky, as are all of Division B’s projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? (Points : 10) 6. (TCO D) Butcher Timber Company hired your consulting firm to help them estimate the cost of common equity. The yield on the firm’s bonds is 8.75%, and your firm’s economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm’s own cost of debt. What is an estimate of the firm’s cost of common from retained earnings? (Points : 10) 7. (TCO F) Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s expected NPV can be negative, in which case it will be rejected. 8. (TCO F) Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s IRR can be less than the WACC (and even negative), in which case it will be rejected. 9. (TCO F) 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 10. (TCO H) TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its three-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s three-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)

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