Q1. Compaq Computers has seen its stock price decline from $45 to $24. The firm

Question

Q1.

Compaq Computers has seen its stock price decline from $45 to $24. The firm expects to reinvest 50% of its $2 billion after-tax operating income in new investments and to earn a return on capital of 10.69%. The firm is currently all equity financed and has a cost of equity of 11.50%. What is the expected impact upon firm value if Compaq makes the new investments?

Select one:

A. $.26 billion destroyed

B. $.89 billion created

C. $1.24 billion destroyed

D. $1.78 billion created

E. None of the above

Q2.

Which of the following statements concerning existing projects is true?

Select one:

a. All projects earning less than their cost of capital should be sold.

b. Some projects earning less than their cost of capital should be sold.

c. No projects earning less than their cost of capital should be sold.

d. Earning the cost of capital should have nothing to do with continuing or selling existing projects.

Explanation / Answer

All projects earning less than their cost of capital should be sold as these will be reducing the value of the company. Hence statement a. is true.

Please post other questions separately. Thanks.

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