Problem Assignments and Solutions - Capital Structure

Problem Assignments and Solutions - Capital Structure
Calculate the correct answer in all problems
USE NPV, Rate, and IRR Functions as appropriate in Problems 4b, 4d. 4e, 5, and 8
Explain in words what the answer means.
Please insert extra rows to hold your work as necessary.
For this problem set, we are not going to give you the exact answer but a range within which the correct answer can be found.  For example, if the problem was “How much is 20 plus 50?” we would say, “The correct answer is between 65 and 75” and you would need to specify the exact answer of “70.”
1 The corporate treasurer of Gonic Manufacturing Company expects the company to grow at 4% in the future.  She notes that debt will have an interest rate of 4% interest and the corporate tax rate is 35%.  She believes that debt will be a cheaper option to finance the growth. The current market price per share of its common stock is $19, and the expected dividend in one year is $0.75 per share.  Calculate the cost of the company's  retained earnings and check if the treasurer's assumption is correct.

The range for the cost of debt is between 2% and 10%
The range for the cost of retained earnings is between 2% and 10%

2-A The risk-free rate on 30 year U.S. Treasury bonds is 2.75% and the expected rate of return on the overall stock market is 7%.  The BOW company has a beta of 1.4. What is the cost of equity?  

The range for the cost of equity is between 6% and 15%

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 1.4. What is the cost of equity?  

The range is between 4% and 9%

3 A company, East  Berwick Enterprises, has a capital structure as follows:        
Total Capital        $1.000.000
Debt        $400.000
Preferred Stock        $100.000
Common Equity        $500.000

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 5%, 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 $24 and $130 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 5% per year. The firm would like to maintain the existing capital structure to finance the new project.

The minimum expected return from a new capital investment project is the WACC plus any additional risk premium.  Since no additional risk is mentioned, please use the WACC.  The results of the calculations are below.

The range for the WACC is between 4% and 9%.

4 East Berwick  is considering two projects for a new investment, but it can afford only one.  It has determined that the appropriate discount rate is 6.13%.  Please answer the following  questions based on the data below:
    Net Cash Flow    
Year    Project A    Project B
0    -$8.000.000    -$10.000.000
1    $1.600.000    $3.900.000
2    $1.850.000    $3.700.000
3    $2.150.000    $3.400.000
4    $2.400.000    $900.000
5    $2.600.000    $300.000
6    $2.800.000    $0

4-A Calculate the payback period for each project. Do Not use the discounted payback method.        
    Project A    Project B
Range: For Project A, the answer is somewhere between 2 and 5 years. Please specify  the exact answer. For Project B The answer is somewhere between 2 and 5 years. Please specify the exact answer.
4-B Calculate the net present value for each project.        
    Project A    Project B
Range: For Project A The answer is somewhere between $1,600,000 and $3,000,000. Please specify the exact answer.
For Project B The answer is somewhere between $500,000 and $900,000. Please specify the exact answer.
4-C Which project do you think will be approved, if only one project can be approved? Why?        
    Project A    Project B
Answer:    Yes    No
Range:  Choose Project A or Project B  Specify your choice and give your reason. 
4-D What would the NPV be if the required rate of return was 10%?        
Answer:    Project A    Project B
Range: For Project A The answer is somewhere between $1,300,000 and $2,000,000. Please specify the exact answer.
4-E What is the Internal rate of return?
Range: For Project A The answer is somewhere between 7% and 16%. Please specify the exact answer.
For Project B The answer is somewhere between $7% and 16%. Please specify the exact answer.
4-F    Which is the best to use for deciding:  Payback, NPV or IRR?  Why?    
        
    Answer:    Your answer
5 A corporate bond for Chase Corp. has a face value of $1,000 and an annual coupon interest rate of 6%. Interest is paid annually.  10 years of the life of the bond remain. The current market price of the bond is $1,198. To the nearest 1/100 0f 1 percent, what is the yield to maturity (YTM) of the bond today?
Range: The answer is somewhere between $2% and 5%. Please specify the exact answer.

6-A Kennebunkport Manufacturing is expected to pay a dividend of $4 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?
Range: The answer is somewhere between $75 and $150. Please specify the exact answer.
6-B If you buy the stock in Kennebunkport Manufacturing (above) at $95 and the stock price grows at the expected rate, What would be your percent return after one year?
Range: The answer is somewhere between 5% and 9%. Please specify the exact answer.

7 On October 15, 2015, A common stock of Nasson Co. sells for $42 per share, has a growth rate of 5% and a dividend that was just paid of $1.84
 in December 2012. What is the annual percent yield per share?

8 A corporate bond for the Maryland Company, LTD has a face value of $1,000 and an annual coupon interest rate of 5%. Interest is paid annually. 12 years of the life of the bond remain. The current market price of the bond is $1,112, and it will mature at $1,000. To the 1/100
 percent, what is the yield to maturity (YTM) of the bond today?
Range: The answer is somewhere between 2% and 6%. Please specify the exact answer.