Fin 370

1. Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt = 10%; preferred stock = 11% and common stock = 18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its current investments if the value of the firm is to remain unchanged?

2. In order for a firm to estimate its cost of debt capital by observing the price of its debt instruments the firm must depend on markets being reasonably efficient. TRUE or FALSE

3. The WACC for a firm is 13.00 percent. You know that the firm’s cost of debt capital is 10 percent and the cost of equity capital is 20%. What proportion of the firm is financed with debt?

4. You are analyzing the cost of capital for a firm that is financed with $300 million of equity and $200 million of debt. The cost of debt capital for the firm is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the firm?

5. The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of retained earnings if the long-term growth in dividends is projected to be 8%?

6. J&B Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently, the yield to maturity on these bonds is 14%. If the firm’s tax rate is 40%, what is the cost of debt to J&B?

7. A pizza maker is deciding whether to purchase a new pizza making machine for $80000. It will be depreciated to zero using straight-line depreciation at the end of its 10 year life where it can be sold for $5000
The old machine was purchased 1 year ago for $36000 when it had an original estimated life of 6 years. The old machine is also being depreciated to zero using the straight-line method.
We could sell the old machine for $29000 today if we decided to purchase the new machine. The old machine would still be useful for another 10 years, but without the benefit of any depreciation. The new machine will give us the ability to produce 12,000 additional pizzas per year.
Pizzas sell for $3 per unit and have variable cost of $1.75 per unit regardless of the machine producing the pizzas. If the new machine is purchased, the pizza maker will incur an additional fixed cost of $200 per year and will require an initial investment in working capital of $100 throughout the life of the project. The marginal tax rate is 40% and the cost of capital is 12%
7a. What is the after-tax cash flow effect from the additional variable cost (act as if that is the only thing that occurs for this question) if the new pizza making machine is chosen?
7b. What is the after-tax cash flow effect from the additional sales (act as if that is the only thing that occurs for this question) if the new pizza making machine is chosen?
7c. What is the initial outlay for purchasing (net of any consequences of selling the old machine) the new machine today?
7d. What is the after-tax cash flow effect from the differential depreciation for years 1 through 5 (act as if that is the only thing that occurs for this question) if the new pizza making machine is chosen?
7e. What is the terminal after-tax cash flow in year 10 (include all cash flows and not just the proceeds from the sale of the new machine)?

8. Provo, inc. had revenues of $10 million, cash operating expenses of $5 million, and depreciation and amortization of $1 million during 2008. The firm purchased $500,000 of equipment during the year while increasing its inventory by $300,000 (with no corresponding increase in current liabilities). The marginal tax rate for Provo is 40 percent. What is Provo’s free cash flow for 2008?

9. Blue Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next 5 years. If the firm’s required rate of return is 18 percent, what is the NPV of this project?

10. John’s Dancing company is considering a project with the following cash flows:
Initial outlay = $750,000
Incremental aftertax cash flows from operations Years 1-4 = $250,000 per year
Compute the NPV of this project if the company’s discount rate is 12%.

11. Johnbull corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13 million, $23 million, and $29 million, over the next three years. The cost of capital is 20 percent. What is the MIRR on this project? Round to the nearest percent.

12. Which ONE of the following statements about the payback method is true?
a. the payback method is consistent with the goal of shareholder wealth maximization
b. The payback method represents the # XXXXX years it takes a project to recover its initial investment plus a require rate of return
c. There is no economic rational that links the payback method to shareholder wealth maximization
d. None of the above are true.

13. You are considering investing in a project with the following year-end after tax cash flows:
Year 1 = $5,000
Year 2 = $3,200
Year 3 = $7,800
If the initial outlay for the project is $12,113, compute the project’s IRR.
14%
Which of the following is NOT true?
a. Accepting a positive-NPV project increases shareholder wealth.
b. Accepting a negative-NPV project has no impact on shareholder wealth.
c. Accepting a negative-NPV project decreases shareholder wealth.
d. Accepting or rejecting a zero NPV project has no impact on shareholder wealth.

14. Binder Corp. has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,520, $823,330, and $907,125 over the next four years. What is the payback period for this project?

15. A company is considering a project with the following incremental cash flows. Assume a discount rate of 10%.
Year 0: ($20,000) cash flow
Year 1: $0 cash flow
Year 2: $30,000 cash flow
Year 3: $30,000 cash flow
Calculate the project’s MIRR. (Round to the nearest whole percentage).