1.

cost of preferred w/flotation problem 10-14

COST OF PREFERRED STOCK INCLUDING FLOTATION Travis Industries plans to issue
perpetual preferred stock with an $11.00 dividend. The stock is currently selling for $108.50, but
flotation costs will be 5% of the market price, so the net price will be $103.08 per share. What is
the cost of the preferred stock, including flotation?
Answer
10.67%

2. cost of equity / CAPM problem 10-6b

COST OF COMMON EQUITY The future earnings, dividends, and common stock price of
Callahan Technologies Inc. are expected to grow 6% per year. Callahan’s common stock
currently sells for $22.00 per share; its last dividend was $2.00; and it will pay a $2.12 dividend
at the end of the current year.
Rs= 14.4%

3. cost of equity / DCF problem 10-4a

COST OF EQUITY WITH AND WITHOUT FLOTATION Jarett & Sons’s common stock
currently trades at $30.00 a share. It is expected to pay an annual dividend of $1.00 a share at the
end of the year (D1 =$1.00), and the constant growth rate is 4% a year. ANSWER: rs = 7.33%

What is the company’s cost of common equity if all of its equity comes from retained earnings?

4. cost of debt problem 10-1, podcast 1, problem 2

AFTER-TAX COST OF DEBT The Holmes Company’s currently outstanding bonds have an 8% coupon and
a 10% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar
yield to maturity. If its marginal tax rate is 40%, what is Holmes’ after-tax cost of debt?
Canyon Corporation expects to earn $2.50 per share, with an expected dividend payout ratio of 80%,
and a constant growth rate of 6%. The company’s common stock is currently selling for $40 per share,
and their investment banker charges 7% when new stock is issued. Canyon’s $1,000 par value bonds
have a 7% annual coupon, 20 years to maturity, and currently sell for $1,055. The company’s capital
structure consists of 40% debt and 60% equity, and their tax rate is 40%. a) What is their WACC if they
do not have to issue new stock? b) What is their WACC if they must issue new stock to raise additional
funds?

Equity: Cost of RE: Rs = (D1/P0) + g= ($2/$40) + 6% = 11.00%

New stock: Rs= D1/[(P0*(1-F)] + g = $2/($40 * 93%) + 6% = 11.38%
Debt: Bonds: N =20 PV = -1055 PMT=70 FV = 1000 CPT I= 6.50%
After tax cost of debt = Rd (1-T) = 6.50 * (1- 0.40) = 3.9%
a) Cost of retained earnings: 11.00%
WACC = 3.9% * 40% + 11.00%* 60% = 1.56%+ 6.60% = 8.16%
b) Cost of new issue stock: 11.38%
WACC= 3.99% * 40% +11.38% * 60% = 1.56% +6.83% = 8.39%

5. WACC calculation podcast 1, problem 3a

Altman Electronics is considering a new project that would require an investment of $480,000 and is
expected to generate $160,000 in after-tax cash flows each year for five years. The company’s target
capital structure is 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 4%,
the cost of preferred is 8%, and the cost of retained earnings is 12%. The firm will not be issuing any new
stock. a) What is the NPV of this project? b) Suppose that after-tax cost of debt went up by 1%, and
changed the firm's WACC from 8.4% to 8.8%. By how much did this WACC change affect the project's
forecasted NPV?

WACC= (wd* Rd) + (wd *Rp) + (Ws * Rs) = (40% *4) + (10% * 8) + 50%* 12) = 8.4%
N=5 I= 8.4 PV= 0 PMT = 160000 FV= 0
CPT PV =632,155 NPV 632,15 – 480000 = 152 155
CFo= -480000 CF1= 160000 F1=5 I=8.4 NPV=152155
 6. rate of return on investment podcast 1, problem 1a
An investor is considering a one-year project that requires an initial investment of $200,000. To raise
this capital will require financing costs that are 3% of the initial investment amount. At the end of the
year, the project is expected to produce a cash inflow of $240,000. a) What is the rate of return
considering flotation costs only? b) If there are capital costs of 5%, what is the return on this
investment?

A) PV= Investment * (1+F) = 206000 FV= Cash inflow = 240000

N=1 CPT I= 16.50%
B) Cost of capital= 200000 * 5% =10000
PV= Investment * (1+F) = 206000 FV= cash inflow – cost= 230000
N=1 CPT I= 11.65%

9. WACC using market value weights problem 10-9, podcast 1, problem 4

Windermere Industries’ balance sheet shows a total of non-callable $60 million long-term debt with a
coupon rate of 7% and a yield to maturity of 5%. This debt currently has a market value of $80 million.
The balance sheet also shows that the company has 3 million shares of common stock, and that the
book value of the common equity is $60 million. The current market value of equity (stock price) is $40
per share. Additionally, stockholders' required return is 14%, and the firm's tax rate is 40%. What is the
company’s WACC based on market value weighting?

10. crossover rate problem 11-15, podcast 2, problem 4a

NPV PROFILES: TIMING DIFFERENCES An oil-drilling company must choose between
two mutually exclusive extraction projects, and each costs $12 million. Under Plan A, all the oil
would be extracted in 1 year, producing a cash flow at t=1 of $14.4 million. Under Plan B, cash
flows would be $2.1 million per year for 20 years. The firm’s WACC is 12%.
1. Construct NPV profiles for Plans A and B, identify each project’s IRR, and show the
approximate crossover rate.
2. Is it logical to assume that the firm would take on all available independent, average-risk projects
with returns greater than 12%? If all available projects with returns greater than 12% have been
undertaken, does this mean that cash flows from past investments have an opportunity cost of
only 12% because all the company can do with these cash flows is to replace money that has a
cost of 12%? Does this imply that the WACC is the correct reinvestment rate assumption for a
project’s cash flows? Why or why not?
Consider the following two situations where Micron Corp. must choose between two mutually exclusive
projects. The firm's WACC is 12%. a) Time Difference (projects A and B): Two mutually exclusive projects
each have a cost of $10 million. Under Plan A, the project will produce cash flows of $2.5 million for 10
years. Under Plan B, the project would produce a single cash flow at t = 1 of $15 million. At what
crossover rate are the NPVs for these two projects the same? At a discount rate of 12%, which project
should the company choose?

11. alternative lease options problem 11-18, podcast 2, problem 3

NPV AND IRR A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month,
60 payments remain, and the next payment is due in 1 month. The mall’s owner plans to sell the
property in a year and wants rent at that time to be high so that the property will appear more
valuable. Therefore, the store has been offered a “great deal” (owner’s words) on a new 5-year
lease. The new lease calls for no rent for 9 months, then payments of $2,600 per month for the
next 51 months. The lease cannot be broken, and the store’s WACC is 12% (or 1% per month).

Should the new lease be accepted? (Hint: Make sure you use 1% per month.)

Answer
No

PV old= - $89,910.08

PV new= -$94,611.45

If the store owner decided to bargain with the mall’s owner over the new lease payment, what
new lease payment would make the store owner indifferent between the new and old leases?
(Hint: Find FV of the old lease’s original cost at t=9; then treat this as the PV of a 51-period
annuity whose payments represent the rent during months 10 to 60.)
Answer
$2,470.80
The store owner is not sure of the 12% WACC—it could be higher or lower. At
what nominal WACC would the store owner be indifferent between the two leases? (Hint:
Calculate the differences between the two payment streams; then find its IRR.)

Answer
22.94%

A company is considering two alternative 5-year leases. The first lease is for $2,000 per month
for 60 months. The second lease has no rent for the first year (12 months), and then even
monthly payments for the remaining 48 months. The company uses a WACC of 9% (monthly
discounting of 0.75% per month) to evaluate such situations. At what lease payment on the
second lease would the company be indifferent between these two options?

12. NPV (even CF) problem 11-1

NPV Project L costs $65,000, its expected cash inflows are $12,000 per year for 9 years, and its
WACC is 9%. What is the project’s NPV?

13. IRR (even CF) problem 11-2

 IRR Refer to problem 11-1. What is the project’s IRR?

Answer
IRR = 11.57%

 What is the project’s IRR?

14. payback period problem 11-4

PAYBACK PERIOD Refer to problem 11-1. What is the project’s payback?

Answer
 5.42 yrs.

15. NPV (uneven CF) problem 11-6a

1. What are the projects’ NPVs assuming the WACC is 5%? 10%? 15%?

Answer
5%: NPVa =$3.52
NPVb = $2.87
10%:NPVa = $0.58
NPVb = $1.04
15%: NPVA = -$1.91
NPVb = -$0.55

What are the projects’ IRRs at each of these WACCs?

Answer: IRRa = 11.10%

IRRb = 13.18%

If the WACC was 5% and A and B were mutually exclusive, which project would you choose?
What if the WACC was 10%? 15%? (Hint: The crossover rate is 7.81%.)

Answer
5%: Choose A

10%: Choose B

15%: Do not choose either one

16. PV (solve for CF0) podcast 2, problem 1
Jackson Corporation is considering a new project that is expected to generate cash inflows of $110,000
for the first 5 years, $185,000 for year 6, and -$80,000 for year 7. If the firm requires a minimum IRR or
"hurdle rate" of 12%, what is the highest initial cost that the company should incur for this project?

17. IRR (uneven CF) problem 11-12

 IRR AND NPV A company is analyzing two mutually exclusive projects, S and L, with the
following cash flows

The company’s WACC is 8.5%. What is the IRR of the better project? (Hint: The better project
may or may not be the one with the higher IRR.)

IRR (larger) = 12.70%

19. MIRR problem 11-13

MIRR A firm is considering two mutually exclusive projects, X and Y, with the following
cash flows:

The projects are equally risky, and their WACC is 11%. What is the MIRR of the project that
maximizes shareholder value?
20. difference between NPVs problem 11-6c, podcast 2, problem 2b
Consider the two projects below, and assume a 13% required rate of return.

Compute the NPV for each project