Financial Planning Problems

Multiple Choice: Problems

(The following information applies to the next four problems. Financial calculator required.)

You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastic goods: plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the Vice-President of Finance. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT.

Assets

Current assets $38,000,000

Net plant, property, and equipment $101,000,000

Total Assets $139,000,000

Liabilities and Equity

Accounts payable $10,000,000

Accruals $9,000,000

Current liabilities $19,000,000

Long term debt (40,000 bonds, $1,000 face value) $40,000,000

Total liabilities $59,000,000

Common Stock 10,000,000 shares) $30,000,000

Retained Earnings $50,000,000

Total shareholders equity $80,000,000

Total liabilities and shareholders equity $139,000,000

You check The Wall Street Journal and see that CGT stock is currently selling for $7.50 per share and that CGT bonds are selling for $889.50 per bond. These bonds have a 7.25 percent annual coupon rate, with semi-annual payments. The bonds mature in twenty years. The beta for your company is approximately equal to 1.1. The yield on a 6-month Treasury bill is 3.5 percent and the yield on a 20-year Treasury bond is 5.5 percent. The expected return on the stock market is 11.5 percent, but the stock market has had an average annual return of 14.5 percent during the past five years. CGT is in the 40 percent tax bracket.

[1]. Using the CAPM approach, what is the best estimate of the cost of equity for CGT?

a. 10.10%

b. 12.10%

c. 12.30%

d. 15.40%

e. 15.60%

[2]. What is best estimate for the after-tax cost of debt for CGT?

a. 2.52%

b. 4.20%

c. 4.35%

d. 5.04%

e. 5.37%

[3]. Which of the following is the best estimate for the weights to be used when calculating the WACCC?

a. w_e = 57.6% and w_d = 42.4%

b. w_e = 65.2% and w_d = 34.8%

c. w_e = 66.7% and w_d = 33.3%

d. w_e = 67.8% and w_d = 32.2%

e. w_e = 72.4% and w_d = 27.6%

[4]. What is the best estimate of the WACC for CGT?

a. 8.65%

b. 8.92%

c. 9.18%

d. 9.75%

e. 9.83%

[5]. Hamilton Company's 8 percent coupon rate, quarterly payment, $1,000 par value bond, which matures in 20 years, currently sells at a price of $686.86. The company's tax rate is 40 percent. Based on the nominal interest rate, not the EAR, what is the firm's component cost of debt for purposes of calculating the WACC?

a. 3.05%

b. 7.32%

c. 7.36%

d. 12.20%

e. 12.26%

[6]. A stock analyst has obtained the following information about J-Mart, a large retail chain:

(1) The company has noncallable bonds with 20 years maturity remaining and a maturity value of $1,000. The bonds have a 12 percent annual coupon and currently sell at a price of $1,273.8564.

(2) Over the past four years, the returns on the market and on J-Mart were as follows:

Year Market J-Mart

2001 12.0% 14.5%

2002 17.2 22.2

2003 -3.8 -7.5

2004 20.0 24.0

(3) The current risk-free rate is 6.35 percent, and the expected return on the market is 11.35 percent. The company's tax rate is 35 percent.

The company anticipates that its proposed investment projects will be financed with 70 percent debt and 30 percent equity. What is the company's estimated weighted average cost of capital (WACC)?

a. 8.04%

b. 9.00%

c. 10.25%

d. 12.33%

e. 13.14%

CHAPTER 9

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