# FI515 Financial Management: Week 6 Exam (Version 4)

FI515 Financial Management

Week 6 Study Guide (Version 4)

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 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year? (Points: 10)

6.50%

6.83%

7.17%

7.52%

7.90%

3. (TCO D) Carter's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return? (Points: 10)

8.03%

8.24%

8.45%

8.67%

8.89%

4. (TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? (Points: 10)

The market risk premium declines.

The flotation costs associated with issuing new common stock increase.

The company's beta increases.

Expected inflation increases.

The flotation costs associated with issuing preferred stock increase.

5. (TCO E) If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely (Points: 10)

become riskier over time, but its intrinsic value will be maximized.

become less risky over time, and this will maximize its intrinsic value.

accept too many low-risk projects and too few high-risk projects.

become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.

6. (TCO D) Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from retained earnings based on the DCF approach? (Points: 10)

9.42%

9.91%

10.44%

10.96%

11.51%

7. (TCO F) Barry Company 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: 12.00%

Year 0 1 2 3 4 5

-----------------------------------------------------------------------

Cash flows -$1,100 $400 $390 $380 $370 $360 (Points: 10)

$250.15

$277.94

$305.73

$336.31

$369.94

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) Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

WACC: 10.00%

Year 0 1 2 3

---------------------------------------------

Cash flows -$900 $500 $500 $500 (Points: 10)

1.88 years

2.09 years

2.29 years

2.52 years

2.78 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

Indicate your choice for your answer - a,b,c,d,e first and then show your work/explain your answer so as to earn partial credit in the event you selected the incorrect answer. (Points: 10)

Week 6 Study Guide (Version 4)

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 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year? (Points: 10)

6.50%

6.83%

7.17%

7.52%

7.90%

3. (TCO D) Carter's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return? (Points: 10)

8.03%

8.24%

8.45%

8.67%

8.89%

4. (TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? (Points: 10)

The market risk premium declines.

The flotation costs associated with issuing new common stock increase.

The company's beta increases.

Expected inflation increases.

The flotation costs associated with issuing preferred stock increase.

5. (TCO E) If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely (Points: 10)

become riskier over time, but its intrinsic value will be maximized.

become less risky over time, and this will maximize its intrinsic value.

accept too many low-risk projects and too few high-risk projects.

become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.

6. (TCO D) Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from retained earnings based on the DCF approach? (Points: 10)

9.42%

9.91%

10.44%

10.96%

11.51%

7. (TCO F) Barry Company 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: 12.00%

Year 0 1 2 3 4 5

-----------------------------------------------------------------------

Cash flows -$1,100 $400 $390 $380 $370 $360 (Points: 10)

$250.15

$277.94

$305.73

$336.31

$369.94

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) Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

WACC: 10.00%

Year 0 1 2 3

---------------------------------------------

Cash flows -$900 $500 $500 $500 (Points: 10)

1.88 years

2.09 years

2.29 years

2.52 years

2.78 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

Indicate your choice for your answer - a,b,c,d,e first and then show your work/explain your answer so as to earn partial credit in the event you selected the incorrect answer. (Points: 10)

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