SQQ CH 10

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Finance

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Jan 9, 2024

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Self-Check Quiz #8 (Ch. 10) Use the following information for the next 3 questions. Landon, the CFO of Marshall Technology Incorporated is planning next year's capital budget. Itis at its optimal capital structure, which is 15 percent (lcit;l and 85 percent common equity, and the company's carnings and dividends are growing at a constant rate of 12 percent. The last dividend, Do, was $1.00, and the company’s stock currently sells at a price of $22 per share. The firm can raise debt at@w:gg_‘_u__mbctbrc‘ tax cost, and is projecting net income to be $2,400,000 with a dividend payout ratio of 25 percent. If the firm issues new common stock, a 7 percent flotation cost will be incurred. ~ The firm's'marginal tax rate is 40 percent. = Ql(\\a\) = ; | -\gv i What is the cost of retained earnings? a. 15.42 percent T 1.1 2 b. 15.78 percent Vo ¥ 5 . —— A& = 1709 =1 7.09% c. 16.54 percent ‘ A aa - d. 16.88 percent s e.) 17.09 percent i If the company ends up spending $3.2 million of new capital, how much new common stock must be sold? M A (C \ 5 a.! $920,000 N1 P b. 80, the firm still has $56,200 of retained earnings to use. Zuwn il ey gy N\ Ko\ 39 y e. None of the above 7 il ‘D‘N\d devxr CE X {”—'_"-] @ | X YW | A3mil) iii Calculate WACC? in the MCC schedule. ¢ D /a) 15.66 percent [ \ v g w FV vV ——— vu b. 1534 percent N = N ¥l 0 \) T Wee (Le) = [ <‘_}:) =) i 1437 porem WKL = 15(00)(1-4) t 5 (L4T) 6~ - 110 14.87 percent e. 14.36 percent \NP'.(,(,; = .19ty 7[@ Qb(\’(ﬂ) .11 V. Project Size R OGS T(239)=11) "V A $6 million 3 11.90% o 20 = 4 B 7 million £ 11.40 \ee1140%% 20 =19 /¢ ili 1 G 8 million | 13.80 il /D 6 million 2 13.00 [ What is the firm's optimal capital budget? ¥ A( a. $21 million $20 million S c. $18 million d. $19 million e. None of the above I\ WAL 6%

v In the previous problem, was it appropriate to use IRR in deciding which projects to accept? You le to answer this question after we finish Chapter 11 a. Yes, since IRR reinvests interim cash flows at the IRR rate. b. Since IRR assumes interim cash flows are reinvested at the IRR rate, it should not have been used. c. No, MIRR should have been used. d. Not really since IRR does not always choose the project that adds the most value to the firm. ¢. Yes, since NPV would have chosen the same group of projects. Use the following information for the next 3 questions. Heather, the CFO of Brown Technology Incorporated is planning next year's capital budget. It is at its optimal capital structure, which is 18 percent debt and 82 percent common equity, and the company's carnings and dividends are growing at a constant rate of 11 percent. The last dividend, Do, was $1_.2_Q.W V’&( ) : - — . s the company’s stock currently sells at a price of $21 per share. The firm can raise debt at a 8 percent before- tax cost, and is projecting net income to be $2,100,000 with a dividend payout ratio of 30 percent. If the ~ . ’—L*‘ » . —— . . firm issues new common stock, a 6 percent flotation cost will be incurred. The firm's marginal tax rate is 40 percent. ~ T7F 29 $1.20(1.10) = P15 vi What is the cost of retained earnings? a. 16.81 percent D \ SN 1.3%5% 2,4-5) i i et SN Tl = 2 =1T1.50% ¢ 17.34 percent 0 J - a d. 16.63 percent Yo \ e. 18.47 percent vii If the company ends up spending $2.5 million of new capital, what would be the breakdown of the common equity used? A /{a\ $1,470,000 retained earnings and $580,000 common stock “b:7 $630,000 retained earnings and $580,000 common stock . " $1,470,000 retained earnings and $560,000 common stock d. $630,000 retained earnings and $560,000 common stock “e. None of the above is within $100 of the correct numbers. NT NeW (a1 NgW Aptal - Net income, L) M 25 M| (CE ik 2 ¥, a4 NaD i T\ ®/ \'23 209 M| — 1.4 Twmy| RE DWID deot A @ viii Calculate WACC?3 in the MCC schedule. (@) 15.42 percent » b. 15.79 percent WACL3 = Wk kd (1-T) + Wee ((ke) —> Ke= - i c. 16.13 percent - d €. 16.37 percent A% (0%) (\—L‘l)) T . Y')\(/‘\’;l{) 16.72 percent 22—t W WACG = .1941q :l\s.wzo ] ke z\(\»‘oa)Jr

a\eate o petunl (vetuvn on prajecy) R AINT AREPT YL phal (”3‘ o V“'W‘) Mg COSt 7 retuvin ix Browne, Incorporated estimates that its break point (BPRE) is $12 million, and its WACC is 9.8 percent if common equity comes from retained carnings. However, if the company issues new stock to raise new common equity, it estimates that its WACC will rise to l()fi.&percer}t. The company is v considering the following equal-life investment projects: 71 3 a wh Project Size IRR @ g‘(‘lg)f B—OD%)T 0.4 ]o Wh(C A $4 million 11.4% z > B 6 million 119 103% P C 3 million v 10.1 D 5 million 10.3 11 ‘(@‘/ What is the firm's optimal capital budget? a. ' $10 million ~ s (\ A ¢ 3 b, $13 million B} 2 > c. $15 million T : d. $18 million JJ b e. None of the above , 2 Questions you should be able to answer: t — TS = } L \0 44'*E@&DBI5 g i 1. Why does a financial analyst use the weighted average cost of capital to evaluate ALL projects rather than using less expensive debt to fund the less profitable projects? 2. Why is there a factor of (1 — T) used on the cost of debt capital, but not on the cost of equity capital? 3. Why did I'use the YTM on an outstanding bond (not new) in the class lecture to calculate the cost of raising debt now? 4. Describe what the Breakpointgrg indicates. 5. Name 3 factors that affect the cost of capital and are beyond the firm’s control. 6. What are three factors under the firm’s control that can affect its cost of capital? Answers to the Multiple Choice: i E ii A iii A iv B v E vi C vii A viii A ix A

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