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Question 1

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Table 9.2

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.

Debt: The firm can sell a 15-year, \$1,000 par value, 8 percent bond for \$1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of \$50.

Common Stock: A firm’s common stock is currently selling for \$75 per share. The dividend expected to be paid at the end of the coming year is \$5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was \$3.10. It is expected that to sell, a new common stock issue must be underpriced \$2 per share and the firm must pay \$1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.

The firm’s cost of a new issue of common stock is ________. (See Table 9.2)

 [removed] 10.2 percent [removed] 14.3 percent [removed] 16.7 percent [removed] 17.0 percent

Table 9.2

A firm has determined its optimal structure which is composed of the following sources and target market value proportions.

Debt: The firm can sell a 15-year, \$1,000 par value, 8 percent bond for \$1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of \$50.
Common Stock: A firm’s common stock is currently selling for \$75 per share. The dividend expected to be paid at the end of the coming year is \$5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was \$3.10. It is expected that to sell, a new common stock issue must be underpriced \$2 per share and the firm must pay \$1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.

The firm’s before-tax cost of debt is ________. (See Table 9.2)

 [removed] 7.7 percent [removed] 10.6 percent [removed] 11.2 percent [removed] 12.7 percent

Table 10.4

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:

The new financial analyst does not like the payback approach (Table 10.4) and determines that the firm’s required rate of return is 15 percent. His recommendation would be to

 [removed] accept projects A and B. [removed] accept project A and reject B. [removed] reject project A and accept B. [removed] reject both.

What is the payback period for Tangshan Mining company’s new project if its initial after tax cost is \$5,000,000 and it is expected to provide after-tax operating cash inflows of \$1,800,000 in year 1, \$1,900,000 in year 2, \$700,000 in year 3 and \$1,800,000 in year 4?

 [removed] 4.33 years [removed] 3.33 years [removed] 2.33 years [removed] None of these

Should Tangshan Mining company accept a new project if its maximum payback is 3.25 years and its initial after tax cost is \$5,000,000 and it is expected to provide after-tax operating cash inflows of \$1,800,000 in year 1, \$1,900,000 in year 2, \$700,000 in year 3 and \$1,800,000 in year 4?

 [removed] Yes. [removed] No. [removed] It depends. [removed] None of these

Which capital budgeting method is most useful for evaluating the following project? The project has an initial after tax cost of \$5,000,000 and it is expected to provide after-tax operating cash flows of \$1,800,000 in year 1, -\$2,900,000 in year 2, \$2,700,000 in year 3 and \$2,300,000 in year 4?

 [removed] NPV [removed] IRR [removed] Payback [removed] Two of these

A firm has common stock with a market price of \$100 per share and an expected dividend of \$5.61 per share at the end of the coming year. A new issue of stock is expected to be sold for \$98, with \$2 per share representing the underpricing necessary in the competitive capital market. Flotation costs are expected to total \$1 per share. The dividends paid on the outstanding stock over the past five years are as follows:

The cost of this new issue of common stock is

 [removed] 5.8 percent. [removed] 7.7 percent. [removed] 10.8 percent. [removed] 12.8 percent.

Evaluate the following projects using the payback method assuming a rule of 3 years for payback.

 [removed] Project A can be accepted because the payback period is 2.5 years but Project B cannot be accepted because its payback period is longer than 3 years. [removed] Project B should be accepted because even thought the payback period is 2.5 years for project A and 3.001 project B, there is a \$1,000,000 payoff in the 4th year in Project B. [removed] Project B should be accepted because you get more money paid back in the long run. [removed] Both projects can be accepted because the payback is less than 3 years.

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