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there is no such thing as optimal capital structure
all the above
none of the above
expression for the total value of the firm is
3 simple
stockshonds
stocks X bonds
stocks + bonds
none of the above
1. If a firmâ€™s earnings and dividends grow from $2.15 per share to $4 per share over an 8year period,
what is the rate of growth?
2. How much would you be willing to pay today for an investment that would return $1,250 each year
for the next 10 years, assuming a discount rate of 12 percent?
EXAMINATION I1
332
3. The riskfree rate is 5 percent, the market return is 12 percent and the stockâ€™s beta coefficient is
1.25. If the dividend expected during the coming year is $3 and grows at an 8 percent rate, at what
price should the stock sell?
The Sawyer Company has just issued $10 million of $1,000â€™8 percent, 10year bonds. Due to the
4.
current market rates the firm had to sell the bonds at a discount of $40 from their face value. ( a )
Calculate the beforetax cost, or yield to maturity, of the bond, using the shortcut formula, and (6)
calculate the aftertax cost of the bond, assuming the firmâ€™s tax rate is 40 percent.
The Desert Products Company is considering six investment proposals of similar risk, for which
5.
the funds available are limited. The projects are independent and have the following initial
investment and present values of cash inflows associated with them:
Project Initial Cost (I) ($) PV ($)
21,000
15,000
A
12,000
B 8,000
7,500
C 5,000
6,400
D 4,000
3,500
2900
E
F 1,900
1,000
(a) Compute the profitability index and NPV for each project. (6) Under capital rationing, which
projects should be selected, assuming a total budget of $25,000?(c) Which projects should be
selected if the total budget is reduced to $24,000?
6. A firm is considering two alternative plans to finance a proposed $7 million investment. Plan A:
Issue debt (9 percent interest rate). Plan B: Issue common stock (at $20 per share, 1million shares
currently outstanding). The companyâ€™s income tax rate is 40 percent. (a) Calculate the indifference
level of EBIT, or the breakeven point for each plan, and ( b )plot these two plans on the EBITEPS
chart.
7. ABC System, Inc., plans to sell new shares of common stock at $35. The flotation cost is 10 percent.
What is the cost of external equity? Both earnings and dividends are expected to grow at a constant
rate of 6 percent and the annual dividend per share is $2.
8. AltaData, Inc., is considering an investment proposal. The companyâ€™s board of directors indicated
that the firmâ€™s present 70 percent ownersâ€™ equity and 30 percent longterm debt structure should
be maintained. The companyâ€™s projected earnings accompanied by periodic common stock sales
will permit it to maintain the present 70 percent ownersâ€™ equity structure of 40 percentage points
from retained earnings and 30 percentage points from common stock.
After consultation with the firmâ€™s investment banker, the company has determined that the
debt could be sold to yield 9 percent and new common stock could be sold to provide proceeds
of $40 per share to the firm. The company is currently paying a dividend of $2 per share, and the
dividends are expected to grow at a constant rate of 6 percent. The firmâ€™s income tax rate is 40
percent.
Calculate the aftertax cost of capital that the company can use for its capital budgeting
decision.
333
EXAMINATION I1
Answers to Examination I1
I. 1 2. F; 3. F; 4. F; 5. T; 6. T; 7. T; 8. F; 9. T; 10. F
.T;
1 . 1 (c); 2. (a); 3. (d); 4. (c); 5. (d); 6.(a); 7. (d);8. (d);9. (a); 10. ( c )
1.
11
1.
1.
, =
F V I F ˜=˜$4.00 1.8605
$2.15
From Appendix A, FVIF8%+8 1.8509. Therefore, the firmâ€™s approximate rate of growth is 8 percent.
=
3.
PO==1
D $3 = $3  $52.17
r g 13.75%  8% 0.0575
(M  V)
I.+ 
*  $80 + ($1,000  $960)/10

Yield to maturity =
+ $960)/2
(M+ V) ($1,000
2
Aftertax cost of debt = 8.57% (1  0.4) = 5.14%
(b)
( a ) NPV = PV  I and the profitability index is PV/I.
5.
Profitability
NPV Index (PI)
Project ($)
A 6,000 1.40
1S O
B 4,000
C 1S O
2,500
D 2,400 1.60
E 1,500 1.75
F 900 1.90
PV NPV PI
Project
$21,000
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