“Problem Assignments and Solutions – Capital StructureCalculate the correct answer in all problemsUSE NPV, Rate, and IRR Functions as appropriate in Problems 4b, 4d. 4e, 5, and 8Explain in words what you do to make each calculationExplain in words what the answers meanPointsQ1
The corporate treasurer of Rollinsford Company expects the company to grow at 3% in
the future, and debt securities at 4%
interest (tax rate = 35%) to be a cheaper option to finance the growth. The current
market price per share of its common stock is $39, and the expected dividend in
one year is $1.50 per share. Calculate
the cost of the company’s retained
earnings and check if the treasurer’s assumption is correct.

2-A
The
risk-free rate on 30 year U.S. Treasury bonds is 3.25% and the expected rate of
return on the overall stock market is 12%.
The company has a beta of 1.6. What is the cost of equity?

2-B
Les argues
that the 10 year note is a better risk free rate at 2%. He also argues that the stock market is too
high and the expected return is really only 5%.
Assume that he is correct. The
company has a beta of 1.6. What is the cost of equity?

3

A
company, West Berwick Enterprises, has
a capital structure as follows:

Total
Capital

$10,00,000

Debt

$4,00,000

Preferred
Stock

$1,00,000

Common
Equity

$5,00,000

What would
be the minimum expected return from a new capital investment project to satisfy
the suppliers of the capital? Assume the applicable tax rate is 40%, interest
on debt is 7%, flotation cost per share of preferred stock is $0.75, and flotation cost per share of common stock is
$4. The preferred and common stocks are selling in the market for $26 and $143
a share respectively, and they are expected to pay a dividend of $1.50 and
$4.50, respectively, in one year. The
company’s dividends are expected to grow at 7% per year. The firm would like to
maintain the existing capital structure to finance the new project.

4
West
Berwick is considering two projects for
a new investment, but it can afford only one.
It has determined that the appropriate discount rate is 7.39%. Please answer the following questions based on the data below:

Net
Cash Flow

Year

Project A

Project B

0

-$40,00,000

-$50,00,000

1

$8,00,000

$19,00,000

2

$10,00,000

$17,00,000

3

$12,00,000

$14,00,000

4

$14,00,000

$9,00,000

5

$16,00,000

$3,00,000

4-A

Calculate
the payback period for each project.

4-B

Calculate
the net present value for each project.

4-C

Which
project do you think will be approved, if only one project can be approved?
Why?

4-D

What if
the required rate of return was 10%?

4-E

What is
the Internal rate of return?

4-F

Which
is the best to use for deciding:
Payback, NPV or IRR? Why?

5
A corporate
bond has a face value of $1,000 and an annual coupon interest rate of 7%.
Interest is paid annually. 10 years of
the life of the bond remain. The current market price of the bond is $1232. To
the nearest 1/100 0f 1 percent, what is the yield to maturity (YTM) of the bond
today?

6-A
Kennebunk
Manufacturing is expected to pay a dividend of $8 per share next year.
The dividend growth rate is expected to continue to be 3%. Required rate of return is 7%. What should be the current market price per
share?

6-B
If you buy
the stock in Kennebunk (above) at $185 and the stock price grows at the expected
rate, What would be your percent return after one year?

Q7
On January
15, 2013, A common stock sells for $82 per share, has a growth rate of 7% and a
dividend that was just paid of $3.82 in December 2012. What is the annual
percent yield per share?

Q8
A corporate
bond has a face value of $1,000 and an annual coupon interest rate of 6%.
Interest is paid annually. 12 years of the life of the bond remain. The current
market price of the bond is $1,127, and it will mature at $1,000. To the 1/10
percent, what is the yield to maturity (YTM) of the bond today?

Q1The
corporate treasurer of Rollinsford Company expects the company to grow at 3% in
the future, and debt securities at 4%
interest (tax rate = 35%) to be a cheaper option to finance the growth. The current
market price per share of its common stock is $39, and the expected dividend in
one year is $1.50 per share. Calculate
the cost of the company’s retained
earnings and check if the treasurer’s assumption is correct.2-AThe
risk-free rate on 30 year U.S. Treasury bonds is 3.25% and the expected rate of
return on the overall stock market is 12%.
The company has a beta of 1.6. What is the cost of equity? 2-BLes argues
that the 10 year note is a better risk free rate at 2%. He also argues that the stock market is too
high and the expected return is really only 5%.
Assume that he is correct. The
company has a beta of 1.6. What is the cost of equity? 3A
company, West Berwick Enterprises, has
a capital structure as follows:Total
Capital$10,00,000Debt$4,00,000Preferred
Stock$1,00,000Common
Equity$5,00,000What would
be the minimum expected return from a new capital investment project to satisfy
the suppliers of the capital? Assume the applicable tax rate is 40%, interest
on debt is 7%, flotation cost per share of preferred stock is $0.75, and flotation cost per share of common stock is
$4. The preferred and common stocks are selling in the market for $26 and $143
a share respectively, and they are expected to pay a dividend of $1.50 and
$4.50, respectively, in one year. The
company’s dividends are expected to grow at 7% per year. The firm would like to
maintain the existing capital structure to finance the new project.4West
Berwick is considering two projects for
a new investment, but it can afford only one.
It has determined that the appropriate discount rate is 7.39%. Please answer the following questions based on the data below:Net
Cash FlowYearProject AProject B0-$40,00,000-$50,00,0001$8,00,000$19,00,0002$10,00,000$17,00,0003$12,00,000$14,00,0004$14,00,000$9,00,0005$16,00,000$3,00,0004-ACalculate
the payback period for each project.4-BCalculate
the net present value for each project.4-CWhich
project do you think will be approved, if only one project can be approved?
Why?4-DWhat if
the required rate of return was 10%?4-EWhat is
the Internal rate of return?4-FWhich
is the best to use for deciding:
Payback, NPV or IRR? Why?5A corporate
bond has a face value of $1,000 and an annual coupon interest rate of 7%.
Interest is paid annually. 10 years of
the life of the bond remain. The current market price of the bond is $1232. To
the nearest 1/100 0f 1 percent, what is the yield to maturity (YTM) of the bond
today?6-AKennebunk
Manufacturing is expected to pay a dividend of $8 per share next year.
The dividend growth rate is expected to continue to be 3%. Required rate of return is 7%. What should be the current market price per
share?6-BIf you buy
the stock in Kennebunk (above) at $185 and the stock price grows at the expected
rate, What would be your percent return after one year?Q7On January
15, 2013, A common stock sells for $82 per share, has a growth rate of 7% and a
dividend that was just paid of $3.82 in December 2012. What is the annual
percent yield per share?Q8A corporate
bond has a face value of $1,000 and an annual coupon interest rate of 6%.
Interest is paid annually. 12 years of the life of the bond remain. The current
market price of the bond is $1,127, and it will mature at $1,000. To the 1/10
percent, what is the yield to maturity (YTM) of the bond today?”