Posted: April 10th, 2016

# If you were told that each project s cost of capital was 10%, which project should be selected?

10 2
LL Incorporated s currently outstanding 11% coupon bonds have a yield to maturity
of 8%. LL believes it could issue at par new bonds that would provide a similar
yield to maturity. If its marginal tax rate is 35%, what is LL s after tax cost
of debt?

10 4
Burnwood Tech plans to issue some \$60 par preferred stock with a 6% dividend.
The stock is selling on the market for \$70.00, and Burnwood must pay flotation
costs of 5% of the market price. What is the cost of the preferred stock?

10 5
Summerdahl Resorts common stock is currently trading at \$36 a share. The stock
is expected to pay a dividend of \$3.00 a share at the end of the year (D1 _ \$3.00),
and the dividend is expected to grow at a constant rate of 5% a year. What is the
cost of common equity?
10 6
Booher Book Stores has a beta of 0.8. The yield on a 3 month T bill is 4% and the
yield on a 10 year T bond is 6%. The market risk premium is 5.5%, but the stock
market return in the previous years was 15%. What is the estimated cost of common
equity using the CAPM?
10 7
Shi Importers balance sheet shows \$300 million in debt, \$50 million in preferred
stock, and \$250 million in total common equity. Shi faces a 40% tax rate and the
following data: rd _ 6%, rps _ 5.8%, and rs _ 12%. If Shi has a target capital structure
of 30% debt, 5% preferred stock, and 65% common stock, what is Shi s
WACC?
10 12
Spencer Supplies stock is currently selling for \$60 a share. The firm is expected to
earn \$5.40 per share this year and to pay a year end dividend of \$3.60.
a. If investors require a 9% return, what rate of growth must be expected for
Spencer?
b. If Spencer reinvests earnings in projects with average returns equal to thestock s expected rate of return, what will be next year s EPS? [Hint: g _ROE(Retention ratio).]
11 13

Cummings Products Company is considering two mutually exclusive investments.
The projects expected net cash flows are as follows:
Expected Net Cash Flows
Year Project A Project B
0 (\$300) (\$405)
1 (387) 134
2 (193) 134
3 (100) 134
4 600 134
5 600 134
6 850 134
7 (180) 0

a. Construct NPV profiles for Projects A and B.
b. What is each project s IRR?
c. If you were told that each project s cost of capital was 10%, which project
should be selected? If the cost of capital was 17%, what would be the proper
choice?
d. What is each project s MIRR at a cost of capital of 10%? At 17%? (Hint:
Consider Period 7 as the end of Project B s life.)
e. What is the crossover rate, and what is its significance?

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