Project #27740 - Cost of Capital and Capital Budgeting

Really need someone who understands business finance.  Must show work for credit.  Thanks!  :)

Chapter 11 – Cost of Capital

1.       Useless tool Co. Inc., has an aftertax cost of debt of 6 percent. With a tax rate of
33 percent, what can you assume the yield on the debt is?

 

 

 

         2. Addison Glass Company has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $925. Addison is in a 25 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be
the same as the yield to maturity on the old issue because the risk and maturity date will
be similar.

a.     Compute the approximate yield to maturity (Formula 11-1) on the old issue and use this as the yield for the new issue.

b.     Make the appropriate tax adjustment to determine the aftertax cost of debt.

a.

 

b.

 

 

         3. Burger Queen can sell preferred stock for $70 with an estimated flotation cost of $2.50.
It is anticipated the preferred stock will pay $6 per share in dividends.

a.     Compute the cost of preferred stock for Burger Queen.

b.     Do we need to make a tax adjustment for the issuing firm?

a.

 

b.

 

 


 

 

         4. The treasurer of BioScience, Inc., is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the following facts, is she correct?

Debt can be issued at a yield of 11 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $50 and pays a dividend of $4.80. The flotation cost on
the preferred stock is $2.10.

 

 

         5. Business has been good for Keystone Control Systems, as indicated by the four-year growth in earnings per share. The earnings have grown from $1.00 to $1.63.

a.     Use Appendix A at the back of the text to determine the compound annual rate of growth in earnings (n = 4).

b.     Based on the growth rate determined in part a, project earnings for next year (E1). Round to two places to the right of the decimal point.

c.     Assume the dividend payout ratio is 40 percent. Compute D1. Round to two places to the right of the decimal point.

d.     The current price of the stock is $50. Using the growth rate (g) from part a and (D1) from part c, compute Ke.

e.     If the flotation cost is $3.75, compute the cost of new common stock (Kn).

 

a.

 

b.

 

c.

 

d.

 

e.

 

 


 

 

Chapter 12 – Capital budgeting

1.Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

 

Earnings before depreciation and taxes                   _____

Depreciation                                                             _____

Earnings before taxes                                               _____

Taxes @ 30%                                                           _____

Earnings after taxes                                                 _____

Depreciation                                                             _____

Cash flow                                                                 _____

 

2.Assume a $100,000 investment and the following cash flows for two alternatives.

Year

Investment A

Investment B

1

$30,000

$40,000

2

50,000

30,000

3

20,000

15,000

4

60,000

15,000

5

50,000

Which of the two alternatives would you select under the payback method?

 

 

 


 

 

3.X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows:

Year

Project A

Project B

1...................

$12,000

$10,000

2...................

8,000

6,000

3...................

6,000

16,000

         a.      Which of the two projects should be chosen based on the payback method?

         b.      Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.

         c.      Should a firm normally have more confidence in answer a or answer b

a.

 

b.

 

c.

 

 

 

4.You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the internal rate of return?

 

 

 

5.Aerospace Dynamics will invest $110,000 in a project that will produce the following cash flows. The cost of capital is 11 percent. Should the project be undertaken? (Note that the fourth year’s cash flow is negative.)

Year

Cash Flow

1................

$36,000

2................

44,000

3................

38,000

4................

(44,000)

5................

81,000

 

 

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Due By (Pacific Time) 04/18/2014 08:00 am
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