1.

               The H Co.s’ currently outstanding bonds have a 10% coupon. If its marginal tax rate is 35% what is H Co.s’ c
Interest rate = 10%
kd before tax= 10%
kd after tax = 10%(1-.35) =6.5%

2.               Tunney Industries can issue perpetual preferred stock at a price of Rs. 47.50 a share. The stock would pay a co
cost of preferred stock (kp) ?
kp= D/p P = D/kp

kp = 3.5/47.5 7.37%

3. The future earnings, dividends, and common stock price of CT Inc. are expected to grow 7% per year. CT’s comm
a.      Using the DCF approach, what is the ke?
b.     If the firm’s beta is 1.6, the risk free rate is 9% and the average return on the market is 13%, what w
c.      If the firm’s bonds earn a return of 12% based on the bond yield plus risk premium approach, what
d.     If you have equal confidence in the inputs used for the 3 approaches, what is your estimate of CT’s

P0 23
D0 2
D1 = D0+ g(D 2.14
g 0.07

a. ke= (D1/P0)+g= 16.30%

b. CAPM=ke= rf+ B(rm-rf) 15.40%
c. ke= 12%+4% 16.00%
d ke= 15.90%

1.               L Engg. has the following capital structure, which it considers to be optimal:
Debt – 25%
Preferred Stock – 15%
Equity – 60%

L Engg. expected net income this year is Rs. 34,285.72. Its established dividend payout ratio is 30%, its tax rate is 40
earnings and dividends to grow at a constant rate of 9%. L Engg. paid a dividend of Rs. 3.60 per share last year, and
per share. It can obtain new capital in the following ways:

Preferred: New preferred stock with a dividend of Rs. 11 can be sold to the public at a price Rs. 95 per s
Debt: Debt can be sold at an interest rate of 12%
Determine the cost of each capital component and WACC.
The Company has following investment opportunities that are average risk projects:
Project Cost Rate of Return
A 10,000 17.40% 1740
B 20,000 16.00% 3200
C 10,000 14.20% 1420
D 20,000 13.70% 2740
E 10,000 12.00% 1200
Which projects should the company accept ? Assume that the company does not want to issue any new

1 Kp div/pref. 11/95 11.58%

2 Kd I(1-t) 12*(1-.4) 7.2
3 Ke (div/eq)+g [3.6+(3.6*.09)]/54+.09 16.27%
WACC (7.2%*25%)+(11.58%*15%)+(16.27%*60%) 13.30%
4 Retained Earnings Breakpoint 0.7(34285.72)/0.6 40000

We will accept project A, B, C, since rate of return is highest in them.

ate is 35% what is H Co.s’ cost of debt (k d) ?

e. The stock would pay a constant annual dividend of Rs. 3.50 a share. What is the company’s

w 7% per year. CT’s common stock currently sells for Rs. 23 per share, its last dividend was Rs. 2 and it will pay a Rs. 2.14 div

the market is 13%, what will be the firm’s cost of common equity using the CAPM approach?
k premium approach, what will be ke?
at is your estimate of CT’s cost of common equity?

atio is 30%, its tax rate is 40%. Investor’s expect future

.60 per share last year, and its stock currently sells for Rs. 54

public at a price Rs. 95 per share.

s not want to issue any new equity?
will pay a Rs. 2.14 dividend at the end of the current year.
 1.               You must analyse two projects, X and Y . Each project costs Rs. 10,000 with the firm’s WACC is 12%. The
cash flows are as follows:
Year Project X Project Y
0 -10000 -10000
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500
MIRR
Project X Yrs 0 1 2 3 4
CFAT -10000 6,500 3000 3000 1,000

1,000
Compounded value 9132.032 3763.2 3360

10000 = 17255.23* pvf @X% for the 4th year

0.57953443680554 = pvf@X% for the 4th year Lies between 14% and 15%

MIRR for Project X 14.61%

MIRR Project Y 13.73%

4. Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units, otherwise, t
plant would
Yrs have toHCC
shut down. Two units LCCare available, HCC and LCC ( for high and low capital costs, respectively). HCC has a
0 -6 -1
1 -0.5 -1.75
2 -0.5 -1.75
3 -0.5 -1.75
4 -0.5 -1.75
5 -0.5 -1.75
7%
NPV of HCC -8.0501
NPV of LCC -8.17535

15%
NPV of HCC ₹ -7.68
NPV of LCC ₹ -6.87

Rs. 22,500 and it is expected to generate after tax cash flows, including depreciation, of Rs. 6,250 per
year. The truck has a 5 year expected life. The expected year end abandonment values ( salvage values

Abandonment
Year Annual CFAT yr 1 yr 2 yr 3 yr4
value
0 -22,500 -
 1 6,250 17,500 23,750 6250 6250 6250
2 6,250 14,000 20,250 6250 6250
3 6,250 11,000 17,250 6250
4 6,250 5,000 11,250
5 6,250 0

NPV ₹ -909.09 ₹ -82.64 ₹ 1,307.29 ₹ 726.73

flows of Rs. 87,000 per year and B. Machine 360 – 6 which has a cost of Rs. 3,60,000, a 6 year life and after tax cash
flows of Rs. 98,300 per year. Assume both projects can be repeated. Knitting machine price are not expected to rise
Yrs A B
0 -190000 -360000
1 87000 98300
2 87000 98300
3 -103000 98300
4 87000 98300
5 87000 98300
6 87000 98300

NPV ₹ 20,069.49 ₹ 22,256.02

b. Would it make sense to wait 2 years before deciding whether to drill?

Drilling today 4.6796 Million

Waiting for 2 years NPV Yr 0 1 2 3

CFAT 0 -9 4.2
0 -9 2.2

You don’t wait and drill today.

’s WACC is 12%. The expected

17255.232

es between 14% and 15%

of the units, otherwise, the highly profitable

respectively). HCC has a high capital cost but

yr.5
 6250
6250
6250
6250
6250

₹ 1,192.42

r life and after tax cash

are not expected to rise,

NPV
4 5 6
4.2 4.2 4.2 90% ₹ 3.56 ₹ 3.21
2.2 2.2 2.2 10% ₹ 0.00 as NPV is negative