# FI515 Financial Management: Week 6 Study Guide (version 1)

FI515 Financial Management
Week 6 Study Guide

1. (TCO D) A share of common stock just paid a dividend of \$1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price? (Points : 10)
\$16.28
\$16.70
\$17.13
\$17.57
\$18.01

2. (TCO D) If D1 = \$1.25, g (which is constant) = 5.5%, and P0 = \$44, what is the stock’s expected total return for the coming year? (Points : 10)
7.54%
7.73%
7.93%
8.13%
8.34%

3. (TCO D) Rebello's preferred stock pays a dividend of \$1.00 per quarter, and it sells for \$55.00 per share. What is its effective annual (not nominal) rate of return? (Points : 10)
6.62%
6.82%
7.03%
7.25%
7.47%

4. (TCO E) Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? (Points : 10)
Increase the dividend payout ratio for the upcoming year.
Increase the percentage of debt in the target capital structure.
Increase the proposed capital budget.
Reduce the amount of short-term bank debt in order to increase the current ratio.
Reduce the percentage of debt in the target capital structure.

5. (TCO E) Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A’s cost of capital is 10.0%, Division B’s cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A’s projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? (Points : 10)
A Division B project with a 13% return.
A Division B project with a 12% return.
A Division A project with an 11% return.
A Division A project with a 9% return.
A Division B project with an 11% return.

6. (TCO D) Butcher Timber Company hired your consulting firm to help them estimate the cost of common equity. The yield on the firm's bonds is 8.75%, and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of common from retained earnings? (Points : 10)
12.60%
13.10%
13.63%
14.17%
14.74%

7. (TCO F) Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

WACC: 10.00%
Year 0 1 2 3
---------------------------------------------
Cash flows -\$950 \$500 \$400 \$300 (Points : 10)
\$54.62
\$57.49
\$60.52
\$63.54
\$66.72

8. (TCO F) Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year 0 1 2 3 4 5
-------------------------------------------------------------------------------------
Cash flows -\$9,500 \$2,000 \$2,025 \$2,050 \$2,075 \$2,100 (Points : 10)
2.08%
2.31%
2.57%
2.82%
3.10%

9. (TCO F) Stern Associates is considering a project that has the following cash flow data. What is the project's payback?
Year 0 1 2 3 4 5
------------------------------------------------------------------------
Cash flows -\$1,100 \$300 \$310 \$320 \$330 \$340 (Points : 10)
2.31 years
2.56 years
2.85 years
3.16 years
3.52 years

10. (TCO H) TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its three-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s three-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)
WACC 10.0%
Pre-tax cash flow reduction for other products (cannibalization) - \$5,000
Investment cost (depreciable basis) \$80,000
Straight-line deprec. rate 33.333%
Sales revenues, each year for three years \$67,500
Annual operating costs (excl. deprec.) - \$25,000
Tax rate 35.0%

a. \$3,636
b. \$3,828
c. \$4,019
d. \$4,220
e. \$4,431