Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Download
Standard view
Full view
of .
Look up keyword
Like this
1Activity
0 of .
Results for:
No results containing your search query
P. 1
Business-Finance Tutorial 6 Continued Answer

Business-Finance Tutorial 6 Continued Answer

Ratings: (0)|Views: 224 |Likes:
Published by Chia Kong Haw

More info:

Published by: Chia Kong Haw on Dec 23, 2010
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as DOCX, PDF, TXT or read online from Scribd
See more
See less

12/23/2010

pdf

text

original

 
ABMF4024 BUSINESS FINANCE Tutorial 6(Cont.) Answer November 10, 2010
Question 1
40% Debt; 60% Common equity; rd = 9%; T = 40%; WACC = 9.96%; rs= ?WACC = (wd)(rd)(1  T) + (wc)(rs)0.0996 = (0.4)(0.09)(1  0.4) + (0.6)rs0.0996 = 0.0216 + 0.6rs0.078 = 0.6rsrs = 13%.
Question 2
P0 = $30; D1 = $3.00; g = 5%; rs= ?
a.
rs =
01
PD
+ g =
00.30$ 00.3$
+ 0.05 = 15%.
b
.
F = 10%; re = ?re =
)F
1(PD
01
+ g =
)
10.01(30$ 00.3$
+ 0.05=
00
.27
 
00
.
¡  
+ 0.05 = 16.11%.
Question 3
a.
rs =
01
PD
+ g =
2
¢ £ 
14
.2
£ 
+ 7% = 9.3% + 7% = 16.3%.
b
.
rs= rRF + (rM  rRF)b= 9% + (13%  9%)1.6 = 9% + (4%)1.6 = 9% + 6.4% = 15.4%.
c
.
rs = Bond rate + Risk premium = 12% + 4% = 16%.
d
.
Since you have equal confidence in the inputs used for the three approaches, anaverage of the three methodologies probably would be warranted.rs =
3%16%4.15%3.16
= 15.9%.
Question 4
Debt = 40%, Common equity = 60%.P0 = $22.50, D0 = $2.00, D1 = $2.00(1.07) = $2.14, g = 7%.rs =
01
PD
+ g =
50.
¤¤ 
$14.
¤ 
$
+ 7% = 16.51%.WACC = (0.4)(0.12)(1 0.4) + (0.6)(0.1651)= 0.0288 + 0.0991 = 12.79%.
 
ABMF4024 BUSINESS FINANCE Tutorial 6(Cont.) Answer November 10, 2010
Question 5
a
. r
d
= 10%, r
d
(1  T) = 10%(0.6) = 6%.D/A = 45%; D
0
= $2; g = 4%; P
0
= $20; T = 40%.Project A: Rate of return = 13%.Project B: Rate of return = 10%.r
s
= $2(1.04)/$20 + 4% = 14.40%.
b
. WACC = 0.45(6%) + 0.55(14.40%) = 10.62%.
c
. Since the firms WACC is 10.62% and each of the projects is equally risky and as riskyas the firms other assets, MEC should accept Project A. Its rate of return is greaterthan the firms WACC. Project B should not be accepted, since its rate of return isless than MECs WACC.
Question 6
If the firm's dividend yield is 5% and its stock price is $46.75, the next expected annualdividend can be calculated.Dividend yield = D
1
/P
0
 5% = D1/$46.75D
1
= $2.3375.Next, the firm's cost of new common stock can be determined from the DCF approach forthe cost of equity.r
e
= D
1
/[P
0
(1  F)] + g= $2.3375/[$46.75(1  0.05)] + 0.12= 17.26%.
Question 7
a
. Examining the DCF approach to the cost of retained earnings, the expected growthrate can be determined from the cost of common equity, price, and expecteddividend. However, first, this problem requires that the formula for WACC be usedto determine the cost of common equity.WACC = w
d
(r
d
)(1  T) + w
c
r
s
 13.0% = 0.4(10%)(1 0.4) + 0.6(r
s
)10.6% = 0.6r
s
 r
s
= 0.17667 or 17.67%.From the cost of common equity, the expected growth rate can now be determined.r
s
= D1/P0 + g0.17667= $3/$35 + gg = 0.090952 or 9.10%.
b
. From the formula for the long-run growth rate:g = (1 Div. payout ratio)
v
ROE = (1  Div. payout ratio)
v
(NI/Equity)0.090952 = (1 Div. payout ratio)
v
($1,100 million/$6,000 million)0.090952 = (1 Div. payout ratio)
v
0.18333330.496104 = (1 Div. payout ratio)Div. payout ratio= 0.503896 or 50.39%.
 
ABMF4024 BUSINESS FINANCE Tutorial 6(Cont.) Answer November 10, 2010
Question 8
a
. With a financial calculator, input N = 5, PV = -4.42, PMT = 0, FV = 6.50, and thensolve for I/YR = g = 8.02%
}
8%.
b
. D
1
= D
0
(1 + g) = $2.60(1.08) = $2.81.
c
. r
s
= D
1
/P
0
+ g = $2.81/$36.00 + 8% = 15.81%.
Question 9
a.
 
r
d
(1  T) = 0.10(1  0.3) = 7%.r
p
= $5/$49 = 10.2%.r
s
= $3.50/$36 + 6% = 15.72%.
b
.
 
WACC:After-tax WeightedComponent Weight
v
Cost = CostDebt[0.10(1 T)] 0.15 7.00% 1.05%Preferred stock 0.10 10.20 1.02Common stock 0.75 15.72 _11.79__
WACC
= 13.86%
c
.
 
Projects 1 and 2 will be accepted since their rates of return exceed the WACC.
Question 10
a
. If all project decisions are independent, the firm should accept all projects whosereturns exceed their risk-adjusted costs of capital. The appropriate costs of capitalare summarized below:Required Rate of Cost of Project Investment Return CapitalA $4 million 14.0% 12%B 5 million 1.5 12C 3 million 9.5 8D 2 million 9.0 10E 6 million 12.5 12F 5 million 12.5 10G 6 million 7.0 8H 3 million 11.5 8Therefore, Ziege should accept projects A, C, E, F, and H.

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->