(TCO D) A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock’s current price?
(TCO D) If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock’s expected capital gains yield for the coming year?
(TCO D) Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?
(TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?
(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?
(TCO D) Scanlon Inc.’s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from retained earnings?
(TCO F) Simkins Renovations Inc. 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.
(TCO F) Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?
(TCO H) Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes, if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s three-year life, after which it would be worth nothing, and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s three-year life. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)
Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right after paying the dividend in one year in order to justify its current price?
4.
Krell Industries has a share price of $22 today. If Krell is expected to pay a dividend of $0.88 this year, and its stock price is expected to grow to $23.54 at the end of the year, what is Krell’s dividend yield and equity cost of capital?
5.
NoGrowth Corporation currently pays a dividend of $2 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year?
6.
Summit Systems will pay a dividend of $1.50 this year. If you expect Summit’s dividend to grow by 6% per year, what is its price per share if its equity cost of capital is 11%?
7.
Dorpac Corporation has a dividend yield of 1.5%. Dorpac’s equity cost of capital is 8%, and its dividends are expected to grow at a constant rate.
a. What is the expected growth rate of Dorpac’s dividends? b. What is the expected growth rate of Dorpac’s share price?
12.
Procter & Gamble will pay an annual dividend of $0.65 one year from now. Analysts expect this dividend to grow at 12% per year thereafter until the fifth year. After then, growth will level off at 2% per year. According to the dividend-discount model, what is the value of a share of Procter & Gamble stock if the firm’s equity cost of capital is 8%?
19.
Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:
Year12345FCF ($ millions)5368787582
After then, the free cash flows are expected to grow at the industry average of 4% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14%:
a. Estimate the enterprise value of Heavy Metal. b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price.
1.
Suppose Pepsico’s stock has a beta of 0.57. If the risk-free rate is 3% and the expected return of the market portfolio is 8%, what is Pepsico’s equity cost of capital?
3.
Aluminum maker Alcoa has a beta of about 2.0, whereas Hormel Foods has a beta of 0.45. If the expected excess return of the marker portfolio is 5%, which of these firms has a higher equity cost of capital, and how much higher is it?
26.
Unida Systems has 40 million shares outstanding trading for $10 per share. In addition, Unida has $100 million in outstanding debt. Suppose Unida’s equity cost of capital is 15%, its debt cost of capital is 8%, and the corporate tax rate is 40%.
In fiscal year 2011, Starbucks Corporation (SBUX) had revenue of $11.70 billion, gross profit of $6.75 billion, and net income of $1.25 billion. Peet’s Coffee and Tea (PEET) had revenue of $372 million, gross profit of $72.7 million, and net income of $17.8 million.
a. Compare the gross margins for Starbucks and Peet’s.
b. Compare the net profit margins for Starbucks and Peet’s.
c. Which firm was more profitable in 2011?
30.
In mid-2012, Apple had cash and short-term investments of $27.65 billion, accounts receivable of $14.30 billion, current assets of $51.94 billion, and current liabilities of $33.06 billion.
a. What was Apple’s current ratio?
b. What was Apple’s quick ratio?
c. What was Apple’s cash ratio?
d. In mid-2012, Dell had a cash ratio of 0.67, a quick ratio of 1.11 and a current ratio of 1.35. What can you say about the asset liquidity of Apple relative to Dell?
31.
See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.
a. How did Mydeco’s accounts receivable days change over this period?
b. How did Mydeco’s inventory days change over this period?
c. Based on your analysis, has Mydeco improved its management of its working capital during this time period?
36.
You are analyzing the leverage of two firms and you note the following (all values in millions of dollars):
DebtBook EquityMarket EquityEBITInterest ExpenseFirm A50030040010050Firm B 80 35 40 8 7a. What is the market debt-to-equity ratio of each firm?b. What is the book debt-to-equity ratio of each firm?c. What is the EBIT/interest coverage ratio of each firm?d. Which firm may have more difficulty meeting its debt obligations? Explain.
42.
For fiscal year 2011, Starbucks Corporation (SBUX) had total revenues of $11.70 billion, net income of $1.25 billion, total assets of $7.36 billion, and total shareholder’s equity of $4.38 billion.
a. Calculate the Starbucks’ ROE directly, and using the DuPont Identity.
b. Comparing with the data for Peet’s in Problem 41, use the DuPont Identity to understand the difference between the two firms’ ROEs.
43.
Consider a retailing firm with a net profit margin of 3.5%, a total asset turnover of 1.8, total assets of $44 million, and a book value of equity of $18 million.
a. What is the firm’s current ROE?
b. If the firm increased its net profit margin to 4%, what would be its ROE?
c. If, in addition, the firm increased its revenues by 20% (while maintaining this higher profit margin and without changing its assets or liabilities), what would be its ROE?
10.
Your firm has identified three potential investment projects. The projects and their cash flows are shown here:
ProjectCash Flow Today ($)Cash Flow in One Year ($)A−1020B 5 5C20−10
Suppose all cash flows are certain and the risk-free interest rate is 10%.
a. What is the NPV of each project?
b. If the firm can choose only one of these projects, which should it choose?
c. If the firm can choose any two of these projects, which should it choose?
3.
Calculate the future value of $2000 in
a. Five years at an interest rate of 5% per year.
b. Ten years at an interest rate of 5% per year.
c. Five years at an interest rate of 10% per year.
d. Why is the amount of interest earned in part (a) less than half the amount of interest earned in part (b)?
4.
What is the present value of $10,000 received
a. Twelve years from today when the interest rate is 4% per year?
b. Twenty years from today when the interest rate is 8% per year?
c. Six years from today when the interest rate is 2% per year?
11.
Suppose you receive $100 at the end of each year for the next three years.
a. If the interest rate is 8%, what is the present value of these cash flows?
b. What is the future value in three years of the present value you computed in (a)?
c. Suppose you deposit the cash flows in a bank account that pays 8% interest per year. What is the balance in the account at the end of each of the next three years (after your deposit is made)? How does the final bank balance compare with your answer in (b)?
12.
You have just received a windfall from an investment you made in a friend’s business. He will be paying you $10,000 at the end of this year, $20,000 at the end of the following year, and $30,000 at the end of the year after that (three years from today). The interest rate is 3.5% per year.
a. What is the present value of your windfall?
b. What is the future value of your windfall in three years (on the date of the last payment)?
27.
Your oldest daughter is about to start kindergarten at a private school. Tuition is $10,000 per year, payable at the beginning of the school year. You expect to keep your daughter in private school through high school. You expect tuition to increase at a rate of 5% per year over the 13 years of her schooling. What is the present value of the tuition payments if the interest rate is 5% per year? How much would you need to have in the bank now to fund all 13 years of tuition?
(TCO A) Which of the following statements is CORRECT?
(TCO G) Which of the following statements is CORRECT?
(TCO G) LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15% ROE, holding everything else constant?
(TCO B) Suppose a State of New York bond will pay $1,000 10 years from now. If the going interest rate on these 10-year bonds is 5.5%, how much is the bond worth today?
(TCO B) Your father paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next five years, then an additional lump sum payment of $10,000 at the end of the fifth year. What is the expected rate of return on this investment?
(TCO B) Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in five equal installments at the end of each of the next five years. How much interest would you have to pay in the first year?
(TCO D) A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?
(TCO D) Ezzell Enterprises’ noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity?
(TCO C) Niendorf Corporation’s five-year bonds yield 6.75%, and five-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for five-year bonds is IP = 1.65%, the default risk premium for Niendorf’s bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf’s bonds?
(TCO C) Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:
Suppose the term structure of risk-free interest rates is as shown below:
Term1 year2 years3 years5 years7 years10 years20 yearsRate (EAR, %)1.992.412.743.323.764.134.93a. Calculate the present value of an investment that pays $1000 in two years and $2000 in five years for certain.b. Calculate the present value of receiving $500 per year, with certainty, at the end of the next five years. To find the rates for the missing years in the table, linearly interpolate between the years for which you do know the rates. (For example, the rate in year 4 would be the average of the rate in year 3 and year 5.)*c. Calculate the present value of receiving $2300 per year, with certainty, for the next 20 years. Infer rates for the missing years using linear interpolation. (Hint: Use a spreadsheet.)
31.
What is the shape of the yield curve given the term structure in Problem 29? What expectations are investors likely to have about future interest rates?
2. Assume that a bond will make payments every six months as shown on the following timeline (using six-month periods):
6.
Suppose a 10-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading for a price of $1034.74.
a. What is the bond’s yield to maturity (expressed as an APR with semiannual compounding)?b. If the bond’s yield to maturity changes to 9% APR, what will the bond’s price be?
7.
Suppose a five-year, $1000 bond with annual coupons has a price of $900 and a yield to maturity of 6%. What is the bond’s coupon rate?
10.
Suppose a seven-year, $1000 bond with an 8% coupon rate and semiannual coupons is trading with a yield to maturity of 6.75%.
a. Is this bond currently trading at a discount, at par, or at a premium? Explain.b. If the yield to maturity of the bond rises to 7% (APR with semiannual compounding), what price will the bond trade for?
28.
The following table summarizes the yields to maturity on several one-year, zero-coupon securities:
a. What is the price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating?b. What is the credit spread on AAA-rated corporate bonds?c. What is the credit spread on B-rated corporate bonds?d. How does the credit spread change with the bond rating? Why?
30.
HMK Enterprises would like to raise $10 million to invest in capital expenditures. The company plans to issue five-year bonds with a face value of $1000 and a coupon rate of 6.5% (annual payments). The following table summarizes the yield to maturity for five-year (annual-pay) coupon corporate bonds of various ratings:
RatingAAAAAABBBBBYTM6.20%6.30%6.50%6.90%7.50%a. Assuming the bonds will be rated AA, what will the price of the bonds be?b. How much total principal amount of these bonds must HMK issue to raise $10 million today, assuming the bonds are AA rated? (Because HMK cannot issue a fraction of a bond, assume that all fractions are rounded to the nearest whole number.)c. What must the rating of the bonds be for them to sell at par?d. Suppose that when the bonds are issued, the price of each bond is $959.54. What is the likely rating of the bonds? Are they junk bonds?
1.
The figure below shows the one-year return distribution for RCS stock. Calculate
a. The expected return.
b. The standard deviation of the return.
30.
What does the beta of a stock measure?
35.
Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 10.6, calculate the expected return of investing in
a. Starbucks’ stock.
b. Hershey’s stock.
c. Autodesk’s stock.
37.
Suppose the market risk premium is 6.5% and the risk-free interest rate is 5%. Calculate the cost of capital of investing in a project with a beta of 1.2.
2.
You own three stocks: 600 shares of Apple Computer, 10,000 shares of Cisco Systems, and 5000 shares of Colgate-Palmolive. The current share prices and expected returns of Apple, Cisco, and Colgate-Palmolive are, respectively, $500, $20, $100 and 12%, 10%, 8%.
a. What are the portfolio weights of the three stocks in your portfolio?b. What is the expected return of your portfolio?c. Suppose the price of Apple stock goes up by $25, Cisco rises by $5, and Colgate-Palmolive falls by $13. What are the new portfolio weights?d. Assuming the stocks’ expected returns remain the same, what is the expected return of the portfolio at the new prices?
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(TCO D) A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock’s current price?
(TCO D) If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock’s expected capital gains yield for the coming year?
(TCO D) Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?
(TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?
(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?
(TCO D) Scanlon Inc.’s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from retained earnings?
(TCO F) Simkins Renovations Inc. 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.
(TCO F) Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?
(TCO H) Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes, if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s three-year life, after which it would be worth nothing, and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s three-year life. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)