Answer the following questions and put calculations: 21. To be accepted, project

Question

Answer the following questions and put calculations:

21. To be accepted, projects that are unusually risky should have to earn IRRs that are ____ those earned by a firm’s typical projects.

a)equal to

b)higher than

c)lower than

d)similar to

22. Dudek Manufacturing's common stock is currently selling for $45/share. Their most recent dividend (annual) was $2.50, and is expected to grow at 5% per year indefinitely. What is Dudek's cost of retained earnings?

a)10.56%

b)10.83%

c)12.14%

d)13.00%

e)17.14%

23. Groves, Inc. pays an annual dividend of $1.22, which is expected to grow at a rate of 5 percent each year. The firm is in a fairly risky business and has a beta of 1.45. The return on the market is 13.5 percent, and the risk-free rate is 9.3 percent. What is the cost of Groves' equity from retained earnings?

a)19.6%

d)13.5%

c)15.4%

d)6.1%

24. Wright Express (WE) has a capital structure that's 30% debt and 70% equity. The firm is considering a project that requires an investment of $2.6 million. To finance this project, WE plans to issue 10-year bonds with a coupon rate of 12% and a yield to investors of 12.4%. If the current risk-free rate is 7% and the expected market return is 14.5%, what is Wright's WACC if its beta is 1.2 and it is subject to a marginal tax rate of 40%?

a)14.9%

b)12.4%

c)13.4%

d)16.0%

25. The following information pertains to the capital structure of a firm: (Problem 8)

Debt: One thousand bonds with a face value of $1,000 and a 10-year term were issued three years ago with a coupon rate of 10%. Today the bonds are selling to yield 10%.

Preferred stock: Ten thousand shares of preferred stock are outstanding with a $9 annual dividend and a $100 face value. Today the shares are selling to yield a 9% return.

Common equity: 100 thousand shares of common stock are outstanding at a current market price of $30 per share.

Develop the firm's market-value based capital structure.

Explanation / Answer

21) b is correct. In order to compensate for higher risk, the IRR should be higher than that of average risk projects.

22) b is correct. Cost of equity, r = D0 x (1 + g) / P + g = 2.5 x 1.05 / 45 + 5% = 10.83%

23) c is correct. Cost of equity = Rf + beta x (Rm - Rf) = 9.3% + 1.45 x (13.5% - 9.3%) = 15.4%

24) c is correct. Cost of equity, ke = 7% + 1.2 x (14.5% - 7%) = 16.0%

WACC = wd x kd x (1 - tax) + we x ke

= 30% x 12.4% x (1 - 40%) + 70% x 16% = 13.4%

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