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?