Need help with 12 questions about Financial Management 313s3

Nov 11th, 2015
Price: $10 USD

Question description

1. The DEF Company is planning a $64 million expansion. The expansion is to be financed by

selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax

required rate of return on debt is 9 percent and the required rate of return on equity is 14

percent. If the company is in the 35 percent tax bracket, what is the firm’s cost of capital?

a. 8.92%

b. 10.74%

c. 11.50%

d. 9.89%


Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a tax

rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued with a

coupon of 9% at a price of $1,098.18 with no flotation costs. The firm has no internal equity

available for investment at this time, but can issue new common stock at a price of $45. The

next expected dividend on the stock is $2.70. The dividend for the firm is expected to grow at

constant annual rate of 5% per year indefinitely. Flotation costs on new equity will be $7.00

per share. The company has the following independent investment projects available:

 Project            Initial Outlay             IRR

     1                  $100,000                  10%

     2                  $10,000                     8.5%

     3                  $50,000                   12.5%

2. Which of the above projects should the company take on?

a. Project 3 only

b. Projects 1, 2 and 3

c. Projects 1 and 3

d. Projects 1 and 2


3. PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred

stock, and $11 million of common equity, based upon current market values. The firm’s yield

to maturity on its bonds is 7.4%, and investors require an 8% return on the firm’s preferred

stock and a 14% return on PrimaCare’s common stock. If the tax rate is 35%, what is

PrimaCare’s WACC?

a. 7.21%

b. 10.18%

c. 12.25%

d. 8.12%

4. JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects

to earn $30 million in net income next year and retain 40% of it, how large can the capital

budget be before common stock must be sold?

a. $15.5 million

b. $7.5 million

c. $16.0 million

d. $12.0 million

5. All else equal, an increase in beta results in:

a. an increase in the cost of retained earnings

b. an increase in the cost of common equity, whether or not the funds come from retained

earnings or newly issued common stock

c. an increase in the cost of newly issued common stock

d. an increase in the after-tax cost of debt

6. Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and

dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5%

of the selling price. What is the cost of Haroldson’s retained earnings?

a. 12.09%

b. 11.78%

c. 11.45%

d. 5.73%

7. A company has preferred stock that can be sold for $21 per share. The preferred stock pays

an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with

the sale of preferred stock equal $1.25 per share. The company’s marginal tax rate is 35%.

Therefore, the cost of preferred stock is:

a. 14.26%

b. 12.94%

c. 18.87%

d. 17.72%

8. Which of the following should NOT be considered when calculating a firm’s WACC?

a. after-tax YTM on a firm’s bonds

b. cost of newly issued preferred stock

c. after-tax cost of accounts payable

d. cost of newly issued common stock

9. Your firm is considering an investment that will cost $920,000 today. The investment will

produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in

year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the

investment’s profitability index?

a. 1.26

b. 1.69

c. 1.21

d. 1.43

10. Your firm is considering investing in one of two mutually exclusive projects. Project A requires

an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next

three years. Project B requires an initial outlay of $2,500 with expected future cash flows of

$1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and

it is not subject to capital rationing. Assuming both projects can be replaced with a similar

investment at the end of their respective lives, compute the NPV of the two chain cycle for

Project A and three chain cycle for Project B.

a. $2,865 and $94

b. $3,528 and $136

c. $5,000 and $1,500

d. $2,232 and $85

11. The capital budgeting manager for XYZ Corporation, a very profitable high technology company,

completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the

analysis and changes the depreciation method to 3-year depreciation. This change will:

a. increase the present value of the NCFs

b. have no effect on the NCFs because depreciation is a non-cash expense

c. only change the NCFs if the useful life of the depreciable asset is greater than 5 years

d. decrease the present value of the NCFs

12. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000

and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs

$120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in

year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects

is 10%. The modified internal rate of return for Project B is:

a. 18.52%

b. 22.80%

c. 19.75%

d. 17.84%

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