1.

Peter gathers information about Timber Company: The last dividend paid is $2, the
current price is $20. Peters required rate of return is 10%.
Peter want to calculate the cost of retained earnings of Timber Company, based on
DCF method.
Statement 1: The constant growth rate of Timber Company is 5%
Statement 2: The next dividend is $2.1
Choose the most accurate answer:
(A) statement 1 alone is sufficient, but statement 2 alone is not sufficient to answer
the question
(B) statement 2 alone is sufficient, but statement 1 alone is not sufficient to answer the
question
(C) both statements taken together are sufficient to answer the question, but neither
statement alone is sufficient
(D) each statement alone is sufficient
(E) statements 1 and 2 together are not sufficient, and additional data is needed to
answer the question
2. Raspberry Inc. hired you as a consultant to help estimate its cost of capital. You
have been provided with the following data. (1) r d = yield on the firms bonds = 5%
and the risk premium over its own debt cost = 3%. (2) r RF = 3%, RPM = 4% and b =
1.5. (3) D1 = $1, P0 = $30 and g = 5% (constant). You were asked to estimate the cost
of equity based on the three most commonly used methods and then to indicate the
difference between the highest and lowest of these estimates. What is that difference?
3. Calculate the required rate of return for Orange Company, assuming that (1)
investors expect a 2% rate of inflation in the future, (2) the real risk-free rate is 2%,
(3) the market risk premium is 4%, (4) Oranges beta of 1.5, and (5) its realized rate of
return has average 12% over the last 5 years.
4. Papaya is considering the purchase of a new machine for $60,000, installed. Papaya
will use the MACRS accelerated method to depreciate the machine, which is
classified as 5-year property (see the following MACRS table for depreciation rates).
Papaya expects to sell the machine at the end of its 3-year operating life for $20,000.
If Papayas marginal tax rate is 40%, what will the after-tax cash flow be when it
disposes of the machine at the end of year 3?
Ownership year
Depreciation rate
1
20%
2
32%
3
19%
4
12%
5
11%
6
6%

5. You were hired as a consultant to Pearl Company, whose target capital structure is
20% debt, 10% preferred, and 70% common equity. The after-tax cost of debt is 4%,
the cost of preferred is 5% and the cost of retained earnings is 6%. The firm will not
be issuing any new stock. What is its WACC?
6. Apple Corporations stock had a required return of 14%, when the risk-free rate was
6% and the market risk premium was 4%. Now suppose there is a shift in investor risk
aversion, and the market risk premium increases by 1%. The risk-free rate and Apples
beta remain unchanged. What is Apple new required return.
7. Blackberry Inc. is considering two average-risk alternative ways of producing its
patented polo shirts. Process S had a cost of $12,000 and will produce net cash flows
of $7,000 per year for 3 years. Process L will cost $18,000 and will produce cash
flows of $6,000 for 6 years. The company has a contract that requires it to produce the
shirts for 6 years, but the patent will expire after 6 years, so the shirts will not be
produced after the 6th year. Inflation is expected to be zero during the next 6 years. If
cash inflows occur at the end of each year, and if the cost of capital is 10%, by what
amount will the better project increase the firms value?
8. You work for Athens Inc., and you must estimate the Year 1 operating cash flow for
a project with the following data. What is the Year 1 operating cash flow?
Sale revenues
$25,000
Depreciation
$5,000
Other operating costs
$10,000
Tax rate
40%
9. Calabash Crab House is considering an investment in mutually exclusive kitchenupgrade projects with the following cash flows:
Project A
Project B
Initial year
-$10,000
-$9,000
Year 1
2,000
200
Year 2
5,000
-2,000
Year 3
8,000
11,000
Year 4
8,000
15,000
Assuming Calabash has a 12.5% cost of capital, which of the following investment
decisions is most appropriate?
a. Accept Project A because its internal rate of return is higher than that of Project B.
b. Accept Project B because its net present value is higher than that of Project A.
c. Accept both projects because they both have positive net present values.
d. Decline both projects.
10. The Seattle Corporation has been presented with an investment opportunity that
will yield cash flows of $30,000 per year in years 1 through 4, $35,000 per year in
years 5 through 9, and $40,000 in year 10. This investment will cost the firm
$150,000 today, and the firms cost of capital is 10%. The undiscounted payback
period for this investment is closest to:

a. 4.86 years

b. 5.23 years

c. 6.24 years

d. Other

11. An analyst has gathered the following data about a company with a 12% cost of
capital:
Project A
Project B
Cost
$15,000
$25,000
Life
5 years
5 years
Cash inflows
$5,000/year
$7,500/year
Project A and B are independent. What should the company do?
a. Accept A, accept B
b. Reject A, reject B
c. Reject A, accept B
d. Accept B, reject B
12. The following data is regarding the Link Company:
- A target debt/equity ratio of 0.5
- Bonds are currently yielding 10%
- Link is a constant growth firm that just paid a dividend of $3.00
- Stock sells for $31.50 per share, and has a growth rate of 5%
- Marginal tax rate is 40%
What is Links after-tax cost of capital?
a. 12.0%
b. 10.5%
c. 12.5%
d. Other
13. Assume that a company has equal amounts of debt, common stock, and preferred
stock. An increase in the corporate tax rate of a firm will cause its weighted average
of capital (WACC) to:
a. rise
b. fall
c. not change
d. more information is needed
14. Assume a firm uses a constant WACC to select investment projects rather than
adjusting the projects for risk. If so, the firm will tend to:
a. accept profitable, low-risk projects and accept unprofitable, high-risk projects.
b. accept profitable, low-risk projects and reject unprofitable, high-risk projects.
c. reject profitable, low-risk projects and accept unprofitable, high-risk projects.
d. reject profitable, low-risk projects and reject un profitable, high-risk projects.

15. What is the variance of a portfolio consisting of $3,500 in stock G and $6,500 in
stock H.

A. .000209
B. .000247
C. .002098
D. .037026
E. .073600
16. What is the expected return for the following stock?

A. 0.055
B. 0.080
C. 0.095
D. 0.105
E. 0.110
17. What is the standard deviation of a portfolio that is invested 40% in stock A and
60% in stock B, given the following information?

A. 2.18%
B. 2.57%
C. 2.69%
D. 2.84%
E. 3.13%