Sample Questions for Final Examination

1. Bouchard Company's stock sells for $20 per share, its last dividend (D™) was $1.00, its growth rate is a constant 6 percent, and the company would incur a flotation cost of 20 percent if it sold new common stock. Retained earnings for the coming year are expected to be $1,000,000, and the common equity ratio is 60 percent. If Bouchard has a capital budget of $2,000,000, what component cost of common equity will be built into the WACC for the last dollar of capital the company raises?

a. 11.30%

b. 11.45%

c. 11.80%

d. 12.15%

e. 12.63%

2. Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm's stock is P™ = $28; its last dividend was D™ = $2.20, and its expected dividend growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?

a. 15.8%

b. 13.9%

c. 7.9%

d. 14.3%

e. 9.7%

3. A company just paid a $2.00 a share dividend on its common stock (D™ = $2.00). The dividend is expected to grow at a constant rate of 7 percent per year. The stock currently sells for $42 a share. If the company issues additional stock, it must pay its investment banker a flotation cost of $1.00 per share. What is the cost of external equity (that is, what is ke)?

a. 11.76%

b. 11.88%

c. 11.98%

d. 12.22%

e. 12.30%
 
 

4. Two projects being considered are mutually exclusive and have the following projected cash flows:

Year Project         A Project B

0 -$50,000             -$50,000

1 15,625                     0

2 15,625                     0

3 15,625                     0

4 15,625                     0

5 15,625                 99,500

If the required rate of return on these projects is 10 percent, which would be chosen and why?

a. Project B because it has the higher NPV.

b. Project B because it has the higher IRR.

c. Project A because it has the higher NPV.

d. Project A because it has the higher IRR.

e. Neither, because both have IRRs less than the cost of capital.

5. Tapley Acquisition Inc. is considering the purchase of Target Company. The acquisition would require an initial investment of $190,000, but Tapley's after- tax net cash flows would increase by $30,000 per year and remain at this new level forever. Assume a cost of capital of 15 percent. Should Tapley buy Target?

a. Yes, because the IRR < the cost of capital.

b. Yes, because the NPV = $30,000.

c. Yes, because the NPV = $10,000.

d. No, because k > IRR.

e. No, because NPV < 0.

6. Green Grocers is deciding among two mutually exclusive projects. The two projects have the following cash flows:

Project A Project B

Time Cash Flows Cash Flows

0 -$50,000 -$30,000

1 10,000 6,000

2 15,000 12,000

3 40,000 18,000

4 20,000 12,000

The company's cost of capital is 10 percent (WACC = 10%). What is the net present value (NPV) of the project with the highest internal rate of return (IRR)?

a. $ 7,090

b. $ 8,360

c. $11,450

d. $12,510

e. $15,200

7. The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14 percent and its tax rate is 40 percent, what is the project's IRR?

a. 8%

b. 14%

c. 18%

d. -5%

e. 12%

8. You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

a. $15,819.27

b. $21,937.26

c. $32,415.85

d. $38,000.00

e. $52,815.71

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