Posted: November 12th, 2015
Finance
1. (15 points) MMC Industrial’s stock has a beta of 1.95 and has a return on
equity of 12%. The company currently pays a dividend of $1.75 per share and the
stock sells for $65. MMC has a retention ratio of current earnings of 70%. The
company is considering a project which would last about 10 to 15 years and the
company plan on issuing new $25 par value preferred stock to help finance the
project. The preferred issue is expected to pay a dividend of $1.60 per share with
flotation costs of 5% and the company’s managers expect to issue 2.5 million
shares. In addition, the company has current debt outstanding which has a coupon
rate of 7% which matures in 22 years. The bond issue currently sells for $1,045
and has a face value of $1,000. The following information is available:
Number of shares of common stock outstanding: 7 million
Total value of debt: $250 million
Dividend yield on the S&P 500 2%
Estimated growth on the S&P 500 4%
10 year treasury yield 2.06%
1 year T-bill yield 0.50%
Marginal tax rate 34%
If you were hired by MMC to estimate the WACC under the assumption that no new
common stock or debt will be issued, and the cost of capital should be appropriate
for use in evaluation projects that are in the same risk class as the assets the
company now operates, what is your final estimate of the WACC? (Be sure to
consider all cost of equity possibilities, and for the dividend growth models, use
the assumption that the company payouts are 80% dividends and 20% repurchases, and
for the market as a whole, payouts are 70% dividends).
2. (5 points) Discuss the meaning of an optimal capital budget and explain how
changes in the capital gains (and dividend) tax rates for investors may affect the
optimal budget for a firm. (A good answer will include a graph of the marginal
cost and marginal return on capital (investment opportunity set) curves).
3. (3 points)In year one of a particular project the XYZ company expects an
increase of inventory of $20,000. Accounts receivable are expected to increase by
$8,000 and accounts payable are expected to increase by $10,000. This will result
in a cash flow of how much? Should this be added or subtracted in year one as part
of the Net Working Capital change?
4. (2 points) A firm has depreciation expenses of $40,000 for year one of a
project and is in the 30% marginal tax bracket. This should create a cash (inflow
or outflow) of how much?
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