Testco Corporation is considering adding a new product line. The cost of the factory and equipment to produce this product is $1,780,000. Company management expects net cash flows from the sale of this product to be $450,000 in each of the next eight years. If Testco uses a discount rate of 12 percent for projects like this, what is the net present value of this project? What is the internal rate of return?
> Suppose the cost of capital of the Gadget Company is 10 percent. If Gadget has a capital structure that is 50 percent debt and 50 percent equity, its before-tax cost of debt is 5 percent, and its marginal tax rate is 20 percent, then its cost of equity c
> Stock A and Stock B are both priced at $50 per share. Stock A has a P/E ratio of 17, while Stock B has a P/E ratio of 24. Which is the more attractive investment, considering everything else to be the same, and why?
> Provide two conditions under which a set of projects might be characterized as mutually exclusive?
> The price of a share of stock is $15.00 on Tuesday, November 14, 2017. The record date for a $0.50 dividend is Friday, November 17, 2017. If there are no taxes on dividends, what would you expect the price of a share to be on each day from November 14 th
> What are the differences between cash flows used in capital budgeting calculations and past accounting earnings?
> Under what circumstances will the sale of an asset result in a taxable gain? How do you estimate the taxes or tax benefits associated with the sale of an asset?
> Management of the Bernie Rubbel Company has just declared a three-for-one stock split. If you own 12,000 shares before the split, how many shares do you own after the split? What if it were a one-for-three reverse stock split?
> Management of the Veil Acts Company just announced that instead of a regular dividend this quarter, it will be repurchasing shares using the same amount of cash that would have been paid in the suspended dividend. Should this be a positive or negative si
> Explain why the after-tax cost of equity (common or preferred) does not have to be adjusted by the marginal income tax rate for the firm?
> What are the key events and dates in the dividend payment process?
> Sunglass Heaven, Inc., is launching a new store in a shopping mall in Houston. The annual revenue of the store depends on the weather conditions in the summer in Houston. The annual revenue will be $240,000 in a sizzling summer, with probability of 0.3;
> You are considering opening another restaurant in the TexasBurgers chain. The new restaurant will have annual revenue of $300,000 and operating expenses of $150,000. The annual depreciation and amortization for the assets used in the restaurant will equa
> Berron Comics, Inc., has borrowed $100 million and is required to pay its lenders $8 million in interest this year. If Berron is in the 35 percent marginal tax bracket, then what is the after-tax cost of debt (in dollars as well as in annual interest) to
> The market value of a firm’s assets is $3 billion. If the market value of the firm’s liabilities is $2 billion, what is the market value of the stockholders’ investment and why?
> Why is it important to discuss the qualifications of the management team in a business plan?
> What else can a business plan be used for?
> How are dividend payouts affected by expected earnings?
> How does a stock dividend differ from other types of dividends?
> How do stock prices react to dividend announcements?
> What is a stock repurchase?
> List and define four types of dividends?
> What kinds of errors can be made when the WACC for a firm is used as the discount rate for evaluating all projects in the firm?
> Do analysts use book values or market values to calculate the weights when they use Equation13.7? Why?
> What is the advantage of using a multistage-growth dividend model, rather than the constant-growth dividend model, to estimate kcs?
> What information is needed to use the CAPM to estimate kcs or kps?
> How do taxes affect the cost of debt?
> What does the WACC for a firm tell us?
> How is a sensitivity analysis used in project analysis?
> How does operating leverage change when there is an increase in the proportion of a project’s costs that are fixed?
> How is the proportion of fixed costs in a project’s cost structure related to the sensitivity of EBITDA and EBIT to changes in revenue?
> Under what circumstance would you replace an old machine that is still operating with a new one?
> Under what conditions is the WACC the appropriate discount rate for a project?
> When choosing between mutually exclusive projects of unequal lives, how can we ensure that the best decision is made?
> Why is it important to understand that cash flow forecasts in an NPV analysis are expected values?
> What are the five general rules for calculating FCF?
> What types of investments should be included in FCF calculations?
> What decision criteria should managers use in selecting projects when a firm faces capital constraints?
> In capital budgeting, what is a conventional cash flow pattern?
> Under what circumstances do the NPV and IRR decision rules always yield the same decision?
> What are the main shortcomings of the payback method?
> Why does the payback period provide a measure of a project’s liquidity risk?
> What is the payback period?
> Under what circumstances can you use the constant-growth dividend formula to estimate kcs?
> If a firm accepts a project with a $10,000 NPV, what is the effect on the value of the firm?
> What three different models are used to value stocks based on different dividend patterns?
> What is NASDAQ?
> Abacus Corporation will pay dividends of $2.25, $2.95, and $3.15 in the next three years. After three years, the dividends are expected to grow at a constant rate of 4 percent per year. If the required rate of return is 14.5 percent, what is the current
> What is the average accounting rate of return (ARR) on a piece of equipment that will cost $1.2 million and that will result in pretax cost savings of $380,000 for the first three years and then $280,000 for the following three years? Assume that the mac
> Flowers Unlimited is considering purchasing an additional delivery truck which will have a seven year useful life. The new truck will cost $42,000. Cost savings with this truck are expected to be $12,800 for the first two years, $8,900 for the following
> Winters Inc. management estimates that the company will generate after-tax free cash flows from the firm (FCFF) of $12.5 million, $16.8 million and $19.7 million, respectively, over the next three years. After that, FCFF are expected to grow at a constan
> You plan to start a business to produce and sell custom kitchen cabinets. The targeted price for each order of cabinets is $10,000. You estimate that you will receive orders for cabinets for eight kitchens in each of the first two months, nine kitchens i
> MasterCard, Inc. completed a 10-for-1 stock split on January 22, 2014. Immediately before the stock split there were 120.38 million shares outstanding at a price of $826.00 per share. After the split how many shares were outstanding, and at what price wo
> How do you estimate the cost of debt for a firm with more than one type of debt?
> What does the price-earnings ratio tell us?
> Why does an ongoing stock repurchase program offer management greater flexibility in distributing value to stockholders than a regular cash dividend?
> Staunton Energy Corporation managers are considering a capital budgeting project to replace some machinery used in one of the company’s oil refineries. Is the company’s WACC the appropriate discount rate to use in the NPV analysis of this project?
> Use the information in questions 13.2 and 13.3 as well as the following information to compute the WACC for Quarri Industries. In addition to common stock, Quarri has 500,000 preferred shares outstanding that pay a quarterly dividend of $0.50 per share a
> Quarri Industries has eight percent coupon bonds outstanding. These bonds have a market price of $954.41, pay interest semiannually, and will mature in 6 years. If the tax rate is 35 percent, what are the pre-tax cost and after-tax cost of this debt?
> Howard Power and Telecommunications Corporation has three divisions. The names of these divisions, along with the after-tax cost of capital for each division and the market value of the assets in each division are as follows: What is the overall after-t
> Paper Christmas Trees Inc. is considering introducing a new line of inexpensive Christmas trees. The initial outlay for the project is $175,000, and the company will have to invest $5,000 in working capital and $10,000 in fixed assets each year during th
> Luminosity Inc. produces modern light fixtures that sell for $150 per unit. The firm’s management is considering purchasing a high-capacity manufacturing machine. If the high-capacity machine is purchased, then the firm’s annual cash fixed costs will be
> The manager of Roy’s Restaurant has determined that if revenues were to increase by 20 percent, then EBIT would increase by 45 percent to $87,000. What would be the corresponding change in EBITDA if revenues increased 20 percent and cash fixed costs are
> How would a capital intensive company fare during good and poor economic times as compared with other companies? Explain?
> Retro Inc. sells vintage football jerseys for $72 each. Variable costs are $58 per unit and total fixed costs (including depreciation and amortization expense) are $84,000 per year. If sales for next year are expected to equal 8,000 jerseys, how much can
> Why do analysts care about the current cost of long-term debt when estimating a firm’s cost of capital?
> You have inherited an apple orchard and want to sell it in the next four years. An expert in apple orchard valuation has estimated the after-tax cash flow you would receive if you sold at the end of each of the next four years as follows: $1,000,000 if y
> Managers of Central Embroidery have decided to purchase a new monogram machine and are considering two alternative machines. The first machine costs $100,000 and is expected to last five years. The second machine costs $160,000 and is expected to last ei
> After examining the NPV analysis for a potential project that would increase the firm’s output by 5 percent, an analyst’s manager tells the analyst to increase the initial fixed capital outlay in the analysis by $480,000. The initial fixed capital outlay
> A division of Virginia City Highlands Manufacturing is considering purchasing for 1,500,000 a machine that automates the process of inserting electronic components onto computer motherboards. The annual cost of operating the machine will be $50,000, but
> You purchased 100 shares of stocks of an oil company, Texas Energy, Inc., at $50 per share. The company has 1 million shares outstanding. Ten days later, Texas Energy announced an investment in an oil field in east Texas. The probability that the investm
> West Street Automotive is considering adding state safety inspections to their service offerings. The equipment necessary to perform these inspections will cost $557,000 and will generate cash flows of $195,000 over each of the next five years. If the co
> What do we know about that project’s IRR if we know that it has a positive NPV?
> You are chairperson of the investment committee at your firm. Five projects have been submitted to your committee for approval this month. The investment required and the project profitability index for each of these projects are presented in the followi
> The preferred stock of Wellcare Inc. is currently trading at $137.50 per share. If the required rate of return is 8 percent and this stock has no maturity date, what is the quarterly dividend paid by this stock? What is the quarterly dividend if the stoc
> What is a dividend yield? What does it tell us?
> How is the WACC for a firm calculated?
> What does NASDAQ stand for? What is NASDAQ?
> Kingston, Inc. management is considering purchasing a new machine at a cost of $4,133,250. They expect this equipment to produce cash flows of $814,322, $863,275, $937,250, $1,017,112, $1,212,960, and $1,225,000 over the next six years. If the appropriat
> What is a stock market index?
> Kresler Autos has preferred shares outstanding that pay annual dividends of $12, and the current price of the shares is $80. What is the after-tax cost of new preferred shares for Kresler if the flotation (issuance) costs for preferred shares are 5 perce
> Two-Stage Rocket paid an annual dividend of $1.25 yesterday, and it is commonly known that the firm’s management expects to increase its dividend by 8 percent for the next two years and by 2 percent thereafter. If the current price of Two-Stage’s common
> Whitewall Tire Co. just paid an annual dividend of $1.60 on its common shares. If Whitewall is expected to increase its annual dividend by 2 percent per year into the foreseeable future and the current price of Whitewall’s common shares is $11.66, what i
> List and describe each of the three methods used to calculate the cost of common stock?
> Estimate the weighted average cost of capital for Coral Gables using your estimated beta and the information in the problem statement in Problem 13.36? Assume that the average and marginal tax rates for Coral Gables are both 25 percent?
> The CFO described in Problem 13.35 asks you to estimate the beta for Coral Gables’s common stock. Since the common stock is not publicly traded, you do not have the data necessary to estimate the beta using regression analysis. However, you have found a
> You are working as an intern at Coral Gables Products, a privately owned manufacturing company. Shortly after you read Chapter 13 in this book, you got into a discussion with the Chief Financial Officer (CFO) at Coral Gables about weighted average cost o
> Why does the market value of the claims on the assets of a firm equal the market value of the assets?
> Hurricane Corporation is financed with debt, preferred equity, and common equity with market values of $20 million, $10 million, and $30 million, respectively. The betas for the debt, preferred stock, and common stock are 0.2, 0.5, and 1.1, respectively.
> Discuss what valuable information would be lost if you decided to use book values in order to calculate the cost of each of the capital components within a firm’s capital structure?
> Enigma Corporation’s management believes that the firm’s cost of capital (WACC) is too high because the firm has been too secretive with the market concerning its operations. Evaluate that statement?
> RetRyder Hand Trucks has a preferred share issue outstanding that pays a dividend of $1.30 per year. The current cost of preferred equity for RetRyder is 9 percent. If RetRyder issues additional preferred shares that pay exactly the same dividend and the
> In your analysis of the cost of capital for a common stock, you calculate a cost of capital using a dividend discount model that is much lower than the calculation for the cost of capital using the CAPM model. Explain a possible source for the discrepanc
> How are taxes accounted for when we calculate the cost of debt?
> You are an external financial analyst evaluating the merits of a stock. Since you are using a dividend discount model approach to evaluate a cost of equity capital, you need to estimate the dividend growth rate for the firm in the future. Describe how yo
> You are analyzing the cost of capital for MacroSwift Corporation, which develops software operating systems for computers. The firm’s dividend growth rate has been a very constant 3 percent per year for the past 15 years. Competition for the firm’s curre
> If a firm’s management anticipates financing a project with a capital mix that is different from its current capital structure, describe how the firm is subjecting itself to a calculation error if its historical WACC is used to evaluate the project?
> For the Imaginary Products firm in Problem 13.24, calculate the appropriate cost of capital for a new project that is financed with the same proportion of debt, preferred shares, and common shares as the firm’s current capital structure. Also assume that
> How does a scenario analysis differ from a sensitivity analysis?
> The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,440.03 per bond. The
> The managers of a firm financed entirely with common stock are evaluating two distinct projects. The first project has a large amount of unsystematic risk and a small amount of systematic risk. The second project has a small amount of unsystematic risk a
