Book used is Financial Management:
Theory & Practice
Chapter 7:
1. A stock is expected
to pay a yearend dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate
of 5% a year forever (g = 5%). If the
company’s expected and required rate of return is 15%, which of the following
statements is CORRECT?
a. The company’s
current stock price is $20.
b. The company’s
dividend yield 5 years from now is expected to be 10%.
c. The constant growth
model cannot be used because the growth rate is negative.
d. The company’s
expected capital gains yield is 5%.
e. The company’s stock
price next year is expected to be $9.50.
2. A share of common
stock has just paid a dividend of $2.00.
If the expected longrun growth rate for this stock is 3.0%, and if
investors’ required rate of return is 10.5%, what is the stock’s intrinsic
value?
3. E. M. Roussakis
Inc.’s stock currently sells for $45 per share.
The stock’s dividend is projected to increase at a constant rate of 4%
per year. The required rate of return on
the stock, rs, is 15.50%. What is Roussakis’
expected price 5 years from now?
4. Carter’s preferred
stock pays a dividend of $1.90 per quarter.
If the price of the stock is $60.00, what is its nominal (not effective)
annual expected rate of return?
5. Schnusenberg
Corporation just paid a dividend of $1.25 per share, and that dividend is
expected to grow at a constant rate of 7.00% per year in the future. The company’s beta is 1.45, the required
return on the market is 10.50%, and the riskfree rate is 4.00%. What is the intrinsic value for
Schnusenberg’s stock?
6. Rentz RVs Inc. (RRV)
is presently enjoying relatively high growth because of a surge in the demand
for recreational vehicles. Management
expects earnings and dividends to grow at a rate of 30% for the next 4 years,
after which high gas prices will probably reduce the growth rate in earnings
and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25.
RRV’s beta is 1.20, the market risk premium is 4.75%, and the riskfree rate is
3.00%. What is the intrinsic value of RRV’s common stock?
7. Using the
information on Rentz RVs Inc. from problem 6, what is the dividend yield
expected for the next year?
8. Suppose Yon Sun
Corporation’s free cash flow during the justended (t = 0) year was $150
million, and FCF is expected to grow at a constant rate of 6% in the
future. If the weighted average cost of
capital is 20%, what is the firm’s value of operations, in millions?
9. Zhdanov, Inc.
forecasts that its free cash flow in the coming year, i.e., at t = 1, will be
$15 million (negative), but
its FCF at t = 2 will be $30 million.
After Year 2, FCF is expected to grow at a constant rate of 4%
forever. If the weighted average cost of
capital is 15%, what is the firm’s value of operations, in millions?
10. Vasudevan, Inc.
forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 15%
and the free cash flows are expected to continue growing at the same rate after
Year 3 as from Year 2 to Year 3,
what is the Year 0 value of operations, in millions?
Chapter 9:
11. Schalheim Sisters
Inc. has always paid out all of its earnings as dividends, and hence has no
retained earnings. This same situation is expected to persist in the
future. The company uses the CAPM to
calculate its cost of equity. Its target
capital structure consists of common stock, preferred stock, and debt. Which of the following events would reduce its
WACC?
a. The market risk premium declines.
b. The flotation costs associated with
issuing new common stock increase.
c. The company’s beta increases.
d. Expected inflation increases.
e. The flotation costs associated with
issuing preferred stock increase.
12. Hettenhouse Company’s
(HC) perpetual preferred stock sells for $105.50 per share, and it pays a $9.50
annual dividend. If the company were to
sell a new preferred issue, it would incur a flotation cost of 5.00% of the
price paid by investors. HC’s marginal
tax rate is 30%. What is the company’s
cost of preferred stock for use in calculating the WACC?
13. Scanlon Inc.’s CFO
hired you as a consultant to help her estimate the cost of capital. You have been provided with the following
data: the risk–free rate of return is 4.00%;
the market risk premium is 6.00%; and Scanlon’s beta is 1.15. Based on the CAPM approach, what is the cost
of equity from retained earnings?
14. Assume that you are a
consultant to Broske Inc., and you have been provided with the following
data: D1 = $1.70; P0 = $45.50; and g =
7.00% (constant). What is the cost of
equity from retained earnings based on the DCF approach?
15. P. Lange Inc. hired your
consulting firm to help them estimate the cost of equity. The yield on Lange’s bonds is 7.25%, and your
firm’s economists believe that the cost of equity can be estimated using a risk
premium of 5.00% over a firm’s own cost of debt. What is an estimate of Lange’s cost of equity
from retained earnings?
16. In their most recent
fiscal year, XYZ, Inc. had net income of $25 million and total common equity of
$200 million. Also, XYZ, Inc. pays out
40% of its earnings as dividends. Using
the Retention Growth Model, what is your best estimate of XYZ’s expected growth
rate?
17. Several years ago the
Pettijohn Company sold a $1,000 par value, noncallable bond that now has 15
years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $950, and the
company’s tax rate is 38%. To issue new
bonds, Pettijohn would incur 3% flotation costs. What is the component cost of debt for use in
the WACC calculation?
18. LePage Co. expects to
earn $2.50 per share during the current year, its expected dividend payout
ratio is 65%, its expected constant dividend growth rate is 6.0%, and its
common stock currently sells for $22.50 per share. New stock can be sold to the public at the
current price, but a flotation cost of 9% would be incurred. What would be the cost of equity from new
common stock?
19. You were hired as a
consultant to Quigley Company, whose target capital structure is 40% debt, 10%
preferred, and 50% common equity. The
interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the
cost of retained earnings is 14.75%, and the tax rate is 34%. The firm will not be issuing any new
stock. What is Quigley’s WACC?
20. Roxie Epoxy’s balance
sheet shows a total of $50 million longterm debt with a coupon rate of 8.00%
and a yield to maturity of 7.00%. This
debt currently has a market value of $55 million. The balance sheet also shows that that the
company has 20 million shares of common stock, and the book value of the common
equity (common stock plus retained earnings) is $65 million. The current stock price is $8.50 per share;
stockholders’ required return, rs, is 14.00%; and the firm’s tax rate is 35%. Based on market value weights, and assuming
the firm is currently at its target capital structure, what WACC should Roxie
use to evaluate capital budgeting projects?
Chapter 10:
21. Projects C and D are
mutually exclusive and have normal cash flows with an initial outflow followed
by a series of positive cash inflows. Project C has a higher NPV if the WACC is
less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?
a. Project D has a higher IRR.
b. Project D is probably larger in scale
than Project C.
c. Project C probably has a faster
payback.
d. Project C has a higher IRR.
e. The crossover rate between the two
projects is below 12%.
22. Frye Foods is considering a project project’s IRR? 

Year: 
0 
1 
2 
3 
4 
5 

Cash 
$1,100 
$325 
$325 
$325 
$325 
$325 

23. Van Auken Inc. is considering a project 

Year 

Cash Flow 

0 
$1,000 

1 
400 

2 
300 

3 
700 

4 
400 

The company’s WACC is 10%. What is the project’s ordinary payback? 
24. Babcock Inc. is considering a project What is the project’s NPV? 

WACC: 
13.00% 

Year: 
0 
1 
2 
3 

Cash 
$950 
$500 
$300 
$400 

25. Garvin Enterprises is considering a data. 

WACC: 
11.00% 

Year: 
0 
1 
2 
3 

Cash 
$1,000 
$500 
$500 
$500 

26. Hindelang Inc. is considering a project What is the project’s MIRR? 

WACC: 
13.00% 

Year: 
0 
1 
2 
3 
4 

Cash 
$900 
$300 
$320 
$340 
$360 

27. Hogwarts
Inc. is considering a project with the following cash flows:
Initial
cash outlay = $2,500,000
After–tax
net operating cash flows for years 1 to 4 = $750,000 per year
Additional
after–tax terminal cash flow at the end of year 4 = $500,000
Compute
the profitability index of this project if Hogwarts’ WACC is 12%.
28.
Anderson Associates is considering two mutually exclusive projects that
have the following cash
flows:
Project A Project B
Year Cash Flow Cash Flow
0 $10,000 $8,000
1 3,000 7,000
2 2,000 3,000
3 6,000 1,000
4 8,000 1,000
At what cost of capital do the two projects
have the same net present value? (That is, what is the crossover rate?)
29. Walker & Campsey
wants to invest in a new computer system, and management has narrowed the
choice to Systems A and B.
System A requires an upfront cost of $100,000, after which it
generates positive aftertax cash flows of $60,000 at the end of each of the
next 2 years. The system could be
replaced every 2 years, and the cash inflows and outflows would remain the
same.
System B also requires an upfront cost of $100,000, after which it
would generate positive aftertax cash flows of $48,000 at the end of each of
the next 3 years. System B can be
replaced every 3 years, but each time the system is replaced, both the cash
outflows and cash inflows would increase by 10%.
The company needs a computer system for 6 years, after which the
current owners plan to retire and liquidate the firm. The company’s cost of capital is 14%. What is the NPV (on a 6year extended basis)
of the system that adds the most value?
30. Using the information
from problem 29 on Walker & Campsey, what is the equivalent annual annuity (EAA) for System A?
Chapter 11: 31. When evaluating a new project, firms should following 

a. 
Changes in net operating working capital attributable 

b. 
Previous 

c. 
The 

d. 
A 

e. 
The 

32. Taussig Technologies is considering two 

Project X 
Project Y 

Expected NPV 
$350,000 
$350,000 

Standard deviation (s_{NPV}) 
$100,000 
$150,000 

Project beta (vs. market) 
1.4 
0.8 

Correlation of the project cash flows with cash flows 
Cash flows are not correlated with the cash 
Cash flows are highlycorrelated with the cash 

Which 

a. 
Project 

b. 
Project 

c. 
Project 

d. 
Project 

e. 
Project 

33. Langston Labs has an overall (composite) 

Project 
Risk 
Expected 

A 
High 
15% 

B 
Average 
12 

C 
High 
11 

D 
Low 
9 

E 
Low 
6 

Which 

a. 
A 

b. 
A, 

c. 
A, 

d. 
A, 

e. 
A, 

34. Which of the following statements is 

a. 
Since depreciation is a cash expense, the faster an 

b. 
Under 

c. 
Corporations 

d. 
Using 

e. 
Using 

35. Which of the following does NOT 

a. 
A 

b. 
A 

c. 
A firm must obtain new equipment for the project, and 

d. 
A 

e. 
A 

36. You work for Athens Inc., and you must 

Sales 
$15,000 

Depreciation 
$4,000 

Cash 
$6,000 

Tax 
38.0% 
37. Fool Proof Software is considering a new 

Equipment 
$75,000 

Sales 
$80,000 

Cash 
$25,000 

Tax 
35.0% 
38. Bing
Services is now in the final year of a project.
The equipment originally cost $20,000, of which 75% has been
depreciated. Bing can sell the used
equipment today for $8,000, and its tax rate is 35%. What is the equipment’s net aftertax salvage
value for use in a capital budgeting analysis?
39. Thomson Media is considering investing in 

WACC 
12.0% 

Net 
$60,000 

Required 
$10,000 

Sales 
$75,000 

Operating 
$30,000 

Expected 
$7,000 

Tax 
35.0% 

40. A project’s base case or
most likely NPV is $50,000, and assume its probability of occurrence is
60%. Assume the best case scenario NPV is 60% higher than the base
case and assume the worst
scenario NPV is 30% lower than the base case. Both the best case scenario and the worst
case scenario
have a 20% probability of occurrence. Find the project’s coefficient of variation.