Problem Assignments - Capital Structure -USE NPV, Rate, and IRR Functions

Problem Assignments - 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 you do to make each calculation

Explain in words what the answers mean

1. 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 $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 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 -$4,000,000 -$5,000,000

1 $800,000 $1,900,000

2 $1,000,000 $1,700,000

3 $1,200,000 $1,400,000

4 $1,400,000 $900,000

5 $1,600,000 $300,000

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?

7. 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?

8. 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?