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5%;
the required return for the market is 2.5 times the risk free rate. Wildcat
Inc.’s stock is 25% more volatile than the market, while Huskies Corp. has a
beta of .7. What is the required return for both stocks? If the market
became less risk adverse, dropping the required return for the market to 2.25
times the risk free rate, while the risk free rate stays the same, explain which
stock will benefit the most from this change?
2. Muscarella Inc. has the following balance sheet and income statement data:
3. Quigley Inc. is considering two financial plans for the coming year.
Management expects sales to be $301,770, operating costs to be $266,545,
assets to be $200,000, and its tax rate to be 35%. In both plans the liabilities
and equity side of the balance sheet is made up on only two components---
debt and equity. Under Plan A it would use 25% debt and 75% common
equity. The interest rate on the debt would 8.8%, but the TIE ratio would
have to be kept at 4.00 or more. Under Plan B the maximum debt that met
the TIE constraint would be employed. Assuming that sales, operating
costs, assets, the interest rate, and the tax rate would all remain constant, by
how much would the ROE change in response to the change in the capital
structure?
4. Prock Petroleum’s stock has a required return of 13%, and the stock sells for
$50 per share. The firm just paid an annual dividend of $1.00, and the
dividend is expected to grow by 30% per year for the next 4 years, so D4 =
$1.00(1.30)^4 = $2.8561. After t = 4, the dividend is expected to grow at a
constant rate of X% per year forever. What is the stock’s expected constant
growth rate after t = 4, i.e., what is X?
5. Assume that you are on the financial staff of Michelson Inc., and you have
collected the following data: (1) The yield on the company’ outstanding
bonds is 8.00%, and its tax rate is 40%. (2) The next expected annual
dividend is $.65 a share, and the dividend is expected to grow at a constant
rate of 6.00% a year. (3) The price of Michelson’s stock is $17.50 per share,
and the flotation cost for selling new shares is F = 10%. (4) The target
capital structure is 45% debt and the balance is common equity. What is
Michelson’s WACC, assuming it must issue new stock to finance its capital
budget?
6. Scanlon Inc. is considering Projects S and L, whose cash flows are shown
below. These projects are mutually exclusive, equally risky, and not
repeatable. If the decision is made by choosing the project with the higher
IRR, how much value, if any, will be forgone?
WACC = 10%
Year 0 1 2 3 4
CFs -$2,050 $750 $760 $770 $780
CFl -$4,300 $1,500 $1,518 $1,536 $1,554
Income Statement
2007
Sales $212,117
Cost of goods sold 166,417
Gross profit $45,700
Selling, general & admin. exp. 34,281
Operating profit $11,419
Interest expense 2,389
Interest income 1,415
Earnings before taxes $10,445
Taxes 2,785
Net income $7,660