Posted: November 12th, 2015

Finance

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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