# Chapter 14

Problems 1-26
Input boxes in tan Output boxes in yellow Given data in blue Calculations in red Answers in green NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel. To install these, click on the Office button then "Excel Options," "Add-Ins" and select "Go." Check "Analyis ToolPak" and "Solver Add-In," then click "OK."

require that

Chapter 14
Question 1 Input Area:

Dividend per share Growth rate Stock price

\$ \$

2.40 5.50% 52

Output Area:

Cost of equity

10.37%

Chapter 14
Question 2 Input Area:

Beta Risk-free rate Market return

1.05 5.3% 12%

Output Area:

Cost of equity

12.34%

Chapter 14
Question 3 Input Area:

Beta Market risk premium T-bill rate Dividend per share Growth rate Stock price

\$ \$

0.85 8.0% 5.0% 1.60 6% 37

Output Area:

RE: CAPM RE: DCF RE

11.80% 10.58% 11.19%

Chapter 14
Question 4 Input Area:

Current dividend Dividends: Year 1 Year 2 Year 3 Year 4 Stock price

\$ \$ \$ \$ \$ \$

1.43 1.05 1.12 1.19 1.30 45.00

Output Area:

Arithmetic average: g1 g2 g3 g4 g RE Geometric average: Geometric growth RE

6.67% 6.25% 9.24% 10.00% 8.04% 11.47%

8.03% 11.46%

Chapter 14
Question 5 Input Area:

Dividend per share Stock price

\$ \$

6.00 96.00

Output Area:

RP

6.25%

Chapter 14
Question 6 Input Area:

Settlement Maturity Price (% of par) Coupon rate Payments per year Tax rate

01/01/08 01/01/23 107 7% 2 35%

Output Area:

Pretax cost Aftertax cost of debt

6.27% 4.08%

Chapter 14
Question 7 Input Area:

Settlement Maturity Coupon rate Price (% of par) Payments per year Tax rate

01/01/08 01/01/31 8% 95 2 35%

Output Area:

a. Pretax cost of debt 8.50% b. Aftertax cost of debt 5.52% c. The after-tax rate is more relevant because that is the actual cost to the company.

Chapter 14
Question 8 Input Area:

Book value of debt issue (1) Second issue Settlement date Maturity date Annual coupon rate Coupons per year Bond price (% of par) Tax rate Book value debt issue (2)

\$

80,000,000 01/01/08 01/01/15 0% 2 61 35% \$35,000,000

Output Area:

Book value of debt Market value of first bond Market value of second bond Market value of debt Pretax cost of second issue Aftertax cost of second issue Aftertax cost of debt

\$ \$ \$ \$

115,000,000 76,000,000 21,350,000 97,350,000 7.188% 4.672% 5.34%

Chapter 14
Question 9 Input Area:

Common stock Preferred stock Debt Cost of equity Cost of preferred stock Cost of debt Tax rate

60% 5% 35% 14% 6% 8% 35%

Output Area:

a. WACC 10.52% b. Since interest is tax deductible and dividends dividends are not, we must look at the aftertax cost of debt, 5.20% Hence, on an aftertax basis, debt is cheaper than the preferred stock.

Chapter 14
Question 10 Input Area:

Debt-to-equity ratio Cost of equity Cost of debt Tax rate

0.65 15% 9% 35%

Output Area:

WACC

11.40%

Chapter 14
Question 11 Input Area:

WACC Cost of equity Cost of debt Tax rate

8.90% 12% 7.9% 35%

Output Area:

D/E

0.8234

Chapter 14
Question 12 Input Area:

Shares outstanding Market price per share Book value per share Bond I Book value Coupon rate Bond price (% of par) Settlement date Maturity date Payments per year Bond II Book value Coupon rate Bond price (% of par) Settlement date Maturity date Payments per year

\$ \$ \$

11,000,000 68 6 70,000,000 7.00% 93.0 01/01/08 01/01/29 2 55,000,000 8.00% 104.0 01/01/08 01/01/14 2

\$

Output Area:

a. BV(E) BV(D) V E/V D/V b. MV(E) MV(D) V E/V D/V

\$ \$ \$

66,000,000 125,000,000 191,000,000 0.3455 0.6545

\$ \$ \$

748,000,000 122,300,000 870,300,000 0.8595 0.1405

The market value weights are more relevant because they represent a more current

valuation of the debt and equity.

Chapter 14
Question 13 Input Area:

Shares outstanding Market price per share Book value per share Bond I Book value Coupon rate Bond price (% of par) Settlement date Maturity date Payments per year Bond II Book value Coupon rate Bond price (% of par) Settlement date Maturity date Payments per year Dividend Growth rate Tax rate

\$ \$ \$

11,000,000 68 6 70,000,000 7.00% 93.0 01/01/08 01/01/29 2 55,000,000 8.00% 104.0 01/01/08 01/01/14 2 4.10 6% 35%

\$

\$

Output Area:

RE Pretax cost of bond I Aftertax cost of bond I Pretax cost of bond II Aftertax cost of bond II Market value of debt Weight of bond I Weight of bond II Company's aftertax cost of debt

\$

12.39% 7.676% 4.990% 7.168% 4.659% 122,300,000 0.5323 0.4677 4.835%

WACC

11.33%

Chapter 14
Question 14 Input Area:

Debt-equity ratio WACC Tax rate a. Cost of equity b. Aftertax cost of debt

1.05 9.40% 35% 14% 6.8%

Output Area:

a. R(D) b. R(E)

7.72% 12.13%

Chapter 14
Question 15 Input Area:

Tax rate Debt Bonds outstanding Settlement date Maturity date Annual coupon rate Coupons per year Bond price (% of par) Common stock Shares outstanding Beta Share price Preferred stock outstanding Shares outstanding Coupon rate Share price Market Market risk premium Risk-free rate

35% 8,000 01/01/08 01/01/28 6.50% 2 92

\$

250,000 1.05 57

\$

15,000 5.00% 93

8.00% 4.50%

Output Area:

Market value of debt Market value of equity Market value of preferred Market value of firm Pretax cost of debt Aftertax cost of debt Cost of equity

\$ \$ \$ \$

7,360,000 14,250,000 1,395,000 23,005,000 7.26% 4.72% 12.90%

Cost of preferred WACC

5.38% 9.83%

Chapter 14
Question 16 Input Area:

Debt Bonds outstanding Settlement date Maturity date Annual coupon rate Coupons per year Bond price (% of par) Common stock Shares outstanding Beta Share price Preferred stock outstanding Shares outstanding Coupon rate Share price Market Market risk premium Risk-free rate Tax rate

105,000 01/01/08 01/01/23 7.50% 2 93

\$

9,000,000 1.25 34

\$

250,000 6.00% 91

8.50% 5.00% 35%

Output Area:

a. Market value of debt Market value of equity Market value of preferred Market value of firm D/V E/V P/V

\$ \$ \$ \$

97,650,000 306,000,000 22,750,000 426,400,000 0.2290 0.7176 0.0534

b. For projects equally as risky as the firm itself, the WACC should be used as the discount rate.

Pretax cost of debt Aftertax cost of debt Cost of equity Cost of preferred WACC

8.33% 5.41% 15.63% 6.59% 12.80%

Chapter 14
Question 17 Input Area:

Project W X Y Z Firms cost of capital Market expected return T-bill rate

Beta 0.80 0.90 1.45 1.60

Project E(R) 10% 12% 13% 15% 11% 11% 5%

Output Area:

a.

Project W X Y Z Project W X Y Z Project W X Y Z

Lower Higher Higher Higher CAPM E(R) 9.80% 10.40% 13.70% 14.60% Accept/Reject Accept Accept Reject Accept

b.

c.

Incorrectly Rejected Correctly Accepted Incorrectly Accepted Correctly Accepted

Chapter 14
Question 18 Input Area:

Cost Debt-equity ratio Equity flotation cost Debt flotation cost

\$

20,000,000 0.75 8% 5%

Output Area:

a. He should look at the weighted average flotation cost, not just the debt cost. b. fT 6.71%

c. Cost \$ 21,439,510 Even if the specific funds are actually being raised completely from debt, the flotation costs and hence true investment cost should be valued as if the firm's target capital structure is used.

Chapter 14
Question 19 Input Area:

Cost Capital structure: Common stock Preferred stock Debt Flotation cost: Common stock Preferred stock Debt

\$

45,000,000

65% 5% 30%

9% 6% 3%

Output Area:

fT Cost \$

0.071 48,413,125

Chapter 14
Question 20 Input Area:

Aftertax cash savings Growth rate Debt-equity ratio Cost of equity Aftertax cost of debt. Adjustment factor

\$

2,700,000 4% 0.90 13% 4.8% 2%

Output Area:

WACC 9.12% Project discount rate 11.12% Breakeven cost \$ 37,943,787 The project should only be undertaken if its cost is less than \$ 37,943,787

Chapter 14
Question 21 Input Area:

Projected cost Flotation costs Equity flotation cost Debt flotation costs

\$ \$

15,000,000 850,000 7% 3%

Output Area:

Total costs f(T) D/E

\$

15,850,000 5.36% 0.6929

Chapter 14
Question 22 Input Area:

Bond 1 2 3 4 Tax rate Payments per year

Coupon Rate 7.00% 8.50% 8.20% 9.80% 34% 2

Price Quote 103.00 108.00 97.00 111.00

Maturity 5 years 8 years 15 1/2 years 25 years

\$ \$ \$ \$

Face value 40,000,000 35,000,000 55,000,000 50,000,000

Output Area:

1 2 3 4 Total

Market value \$ 41,200,000 \$ 37,800,000 \$ 53,350,000 \$ 55,500,000 \$ 187,850,000 Bond 1 01/01/08 01/01/13 7.00% 2 103.00 100.00 6.29% 4.15%

Weight 0.2193 0.2012 0.2840 0.2954

Settlement date Maturity date Annual coupon rate Coupons per year Face value (% of par) Bond price (% of par) Pretax cost Aftertax cost Pretax cost of debt Company's aftertax cost of debt

Bond 2 01/01/08 01/01/16 8.50% 2 108.00 100.00 7.17% 4.73% 7.82% 5.16%

Bond 3 01/01/08 07/01/24 8.20% 2 97.00 100.00 8.54% 5.64%

Bond 4 01/01/08 01/01/33 9.80% 2 111.00 100.00 8.71% 5.75%

Chapter 14
Question 23 Input Area:

Beta Dividend per share Growth rate Market return T-bill rate Stock price

\$

\$

1.50 0.80 5.0% 12.0% 5.5% 61.00

Output Area:

a. RE: DCF b. RE: CAPM

6.38% 15.25%

c. When using the dividend growth model or the CAPM, you must remember that both are only estimates for the cost of equity. Additionally, and perhaps more importantly, each method of estimating the cost of equity depends upon different assumptions.

Chapter 14
Question 24 Input Area:

Debt-to-equity ratio Projected cost Aftertax cash flows Equity floatation costs Required return Debt floatation costs Coupon rate Target ratio A/P to LTD A/P floatation costs Tax rate

\$ \$

0.70 45,000,000 6,200,000 8% 14% 4% 8% 20% 0% 35%

Output Area:

WACC Floatation costs Project cost NPV

\$ \$

10.76% 6.08% 47,912,317 9,719,777

Chapter 14
Question 25 Input Area:

Debt-to-equity ratio Projected cost Equity floatation costs Debt floatation costs Percentage equity raised internally

\$

1.20 145,000,000 8% 3.50% 0%

Output Area:

wD wE Floatation costs Project cost \$

54.55% 45.45% 5.55% 153,512,993

Chapter 14
Question 26 Input Area:

Land price Current land value Land value in 5 years Plant & Equipment cost Debt Bonds outstanding Settlement date Maturity date Annual coupon rate Coupons per year Face value (% of par) Bond price (% of par) Common stock Shares outstanding Beta Share price

\$ \$ \$ \$

4,000,000 5,100,000 6,000,000 35,000,000

240,000 01/01/08 01/01/28 7.50% 2 100 94

\$

9,000,000 1.20 71.00

Preferred stock outstanding Shares outstanding Coupon rate Share price \$ Market Market risk premium Risk-free rate Equity floatation cost Preferred floatation cost Debt floatation cost Tax rate Net working capital Does the NWC require floatation costs (Yes/No) b. Adjustment factor c. Life of plant (years) Life of project (years) Plant salvage value d. Annual fixed costs # RDS manufactured Sale price per RDS Variable costs per RDS

400,000 5.50% 81.00

8.00% 5.00% 8.00% 6.00% 4.00% 35% 1,300,000 No 2% 8 5 6,000,000 7,000,000 18,000 10,900 9,400

\$

\$ \$ \$ \$

Output Area:

Market value of debt Market value of equity Market value of preferred Market value of firm D/V E/V P/V

\$ \$ \$ \$

225,600,000 639,000,000 32,400,000 897,000,000 0.2515 0.7124 0.0361

a. Floatation costs 0.0692 The cost of the land 3 years ago is a sunk cost and is irrelevant. Land \$ (5,100,000) Plant (including floatation) \$ (37,602,765) Net working capital \$ (1,300,000) \$ (44,002,765) b. Pretax cost of debt Aftertax cost of debt Cost of equity Cost of preferred WACC Discount rate for project c. Book value in year 5 Aftertax salvage value d. Sales Variable costs Fixed costs Depreciation EBIT Taxes Net income Depreciation Operating cash flow e. Accounting breakeven f. Year 0 1 2 3 4 5 IRR NPV \$ \$ \$ \$ \$ \$ \$ \$ \$ \$ \$ 8.11% 5.27% 14.60% 6.79% 11.97% 13.97% 13,125,000 8,493,750 196,200,000 (169,200,000) (7,000,000) (4,375,000) 15,625,000 (5,468,750) 10,156,250 4,375,000 14,531,250 7,583 Cash Flow (44,002,765) 14,531,250 14,531,250 14,531,250 14,531,250 30,325,000

\$ \$ \$ \$ \$ \$

25.25% \$ 14,130,713.81