Reference no: EM131041531

The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 4% per year in the future. Shelby's common stock sells for $20.50 per share, its last dividend was $2.00, and the company will pay a dividend of $2.08 at the end of the current year.

1.

2. If the firm's beta is 2.0, the risk-free rate is 5%, and the expected return on the market is 14%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places.

3. If the firm's bonds earn a return of 10%, and analysts estimate the market risk premium is 3 to 5 percent, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach? Round your answer to two decimal places. (Hint: Use the midpoint of the risk premium range).

4. On the basis of the results of parts a through c, what would be your estimate of Shelby's cost of equity? Assume Shelby values each approach equally. Round your answer to two decimal places.

Bond Yield and After-Tax Cost of Debt

A company's 8% coupon rate, semiannual payment, $1,000 par value bond that matures in 30 years sells at a price of $556.88. The company's federal-plus-state tax rate is 35%. What is the firm's after-tax component cost of debt for purposes of calculating the WACC? (Hint: Base your answer on the nominal rate.) Round your answer to two decimal places.

Cost of Equity

Radon Homes's current EPS is $7.11. It was $4.75 5 years ago. The company pays out 35% of its earnings as dividends, and the stock sells for $36.

1. Calculate the historical growth rate in earnings. (Hint: This is a 5-year growth period.) Round your answer to two decimal places.

2. Calculate the next expected dividend per share, D1 (Hint: D0 = 0.35($7.11) = $2.49). Assume that the past growth rate will continue. Round your answer to the nearest cent.

3. What is Radon's cost of equity, rs? Round your answer to two decimal places.

Calculation of g and EPS

Spencer Supplies's stock is currently selling for $60 per share. The firm is expected to earn $6.00 per share this year and to pay a year-end dividend of $4.00.

1. If investors require a 10% return, what rate of growth must be expected for Spencer? Round your answer to two decimal places.

2. If Spencer reinvests earnings in projects with average returns equal to the stock's expected rate of return, then what will be next year's EPS? (Hint: g = ROE × Retention ratio.) Round your answer to the nearest cent.

The Cost of Equity and Flotation Costs

Messman Manufacturing will issue common stock to the public for $30. The expected dividend and growth in dividends are $4.00 per share and 6%, respectively. If the flotation cost is 13% of the issue's gross proceeds, what is the cost of external equity, re? Round your answer to two decimal places.

The Cost of Equity and Flotation Costs

Suppose a company will issue new 25-year debt with a par value of $1,000 and a coupon rate of 8%, paid annually. The tax rate is 40%. If the flotation cost is 3% of the issue proceeds, then what is the after-tax cost of debt? Disregard the tax shield from the amortization of flotation costs. Round your answer to two decimal places.

WACC Estimation

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $10 million in new projects. The firm's present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt.
Debt $30,000,000
Common equity 30,000,000
Total capital $60,000,000

New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so $1.20/$30 = 4%.) The marginal corporate tax rate is 40%.

1. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Enter your answer in dollars. For example, $1.2 million should be entered as $1200000.

2. Assuming there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity, what is its WACC? Round your answer to two decimal places.

NPV

A project has an initial cost of $67,850, expected net cash inflows of $10,000 per year for 12 years, and a cost of capital of 8%. What is the project's NPV? (Hint: Begin by constructing a time line.) Do not round your intermediate calculations. Round your answer to the nearest cent.

IRR

A project has an initial cost of $52,125, expected net cash inflows of $12,000 per year for 8 years, and a cost of capital of 11%. What is the project's IRR? Round your answer to two decimal places.

MIRR

A project has an initial cost of $72,825, expected net cash inflows of $11,000 per year for 10 years, and a cost of capital of 8%. What is the project's MIRR? Round your answer to two decimal places.

Profitability Index

A project has an initial cost of $74,975, expected net cash inflows of $12,000 per year for 7 years, and a cost of capital of 12%. What is the project's PI? Do not round your intermediate calculations. Round your answer to two decimal places.

Payback

A project has an initial cost of $47,425, expected net cash inflows of $12,000 per year for 7 years, and a cost of capital of 12%. What is the project's payback period? Round your answer to two decimal places.

years

Discounted Payback

A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 9 years, and a cost of capital of 11%. What is the project's discounted payback period? Round your answer to two decimal places.
years

NPV

Your division is considering two investment projects, each of which requires an up-front expenditure of $17 million. You estimate that the investments will produce the following net cash flows:
Year Project A Project B
1 $ 6,000,000 $20,000,000
2 10,000,000 10,000,000
3 20,000,000 7,000,000
1. What are the two projects' net present values, assuming the cost of capital is 5%? Round your answers to the nearest dollar.
Project A $

Project B $

What are the two projects' net present values, assuming the cost of capital is 10%? Round your answers to the nearest dollar.
Project A $
Project B $

What are the two projects' net present values, assuming the cost of capital is 15%? Round your answers to the nearest dollar.
Project A $
Project B $

2. What are the two projects' IRRs at these same costs of capital? Round your answers to two decimal places.
Project A %
Project B %

NPVs, IRRs, and MIRRs for Independent Projects
Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year's capital budget. The projects are independent. The cash outlay for the truck is $19,000, and that for the pulley system is $20,000. The firm's cost of capital is 12%. After-tax cash flows, including depreciation, are as follows:

Year Truck Pulley
1 $5,100 $7,500
2 5,100 7,500
3 5,100 7,500
4 5,100 7,500
5 5,100 7,500

1. Calculate the IRR for each project. Round your answers to two decimal places.
Truck: %
What is the correct accept/reject decision for this project?

Pulley: %
What is the correct accept/reject decision for this project?

2. Calculate the NPV for each project. Round your answers to the nearest dollar, if necessary. Enter each answer as a whole number. For example, do not enter 1,000,000 as 1 million.
Truck: $
What is the correct accept/reject decision for this project?

Pulley: $
What is the correct accept/reject decision for this project?

3. Calculate the MIRR for each project. Round your answers to two decimal places.
Truck: %
What is the correct accept/reject decision for this project?

Pulley: %

What is the correct accept/reject decision for this project?

Nonconstant Growth Stock Valuation

Assume that the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 30% the following year, after which growth should return to the 4% industry average. If the last dividend paid (D0) was $3, what is the value per share of your firm's stock? Round your answer to the nearest cent. Do not round your intermediate computations.

Constant Growth Valuation

Crisp Cookware's common stock is expected to pay a dividend of $1.5 a share at the end of this year (D1 = $1.50); its beta is 1.20; the risk-free rate is 4.6%; and the market risk premium is 5%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $40 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., what is )? Do not round intermediate steps. Round your answer to the nearest cent.