5. The cost of new common stock True or False: The following statement accurately describes how firms make decisions related to issuing new common stock. The cost of issuing new common stock is calculated the same way as the cost of raising equity capital from retained earnings.

True: The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of retained earnings is based on the firm’s existing common equity, while the cost of new common stock is based on the value of the firm’s share price net of its flotation cost.

False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings.

Alpha Moose Transporters is considering investing in a one-year project that requires an initial investment of $475,000. To do so, it will have to issue new common stock and will incur a flotation cost of 2.00%. At the end of the year, the project is expected to produce a cash inflow of $595,000. The rate of return that Alpha Moose expects to earn on its project (net of its flotation costs) is _____(I think)22.81% (rounded to two decimal places).

Sunny Day Manufacturing Company has a current stock price of $33.35 per share, and is expected to pay a per-share dividend of $2.03 at the end of the year. The company’s earnings’ and dividends’ growth rate are expected to grow at the constant rate of 9.40% into the foreseeable future. If Sunny Day expects to incur flotation costs of 5.00% of the value of its newly-raised equity funds, then the flotation-adjusted (net) cost of its new common stock (rounded to two decimal places) should be_____(I think)15.49% . Alpha Moose Transporters Co.’s addition to earnings for this year is expected to be $857,000. Its target capital structure consists of 40% debt, 5% preferred, and 55% equity. Determine Alpha Moose Transporters’s retained earnings breakpoint:

$2,142,500 $1,869,818 $1,791,909 $1,558,182

6. Solving for the WACC The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is an appropriate discount rate only for a project of average risk.

Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address.

Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%.

If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%.

If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.)

0.96% 1.34% 1.07% 1.28%

Turnbull Co. is considering a project that requires an initial investment of $570,000. The firm will raise the $570,000 in capital by issuing $230,000 of debt at a before-tax cost of 8.7%, $20,000 of preferred stock at a cost of 9.9%, and $320,000 of equity at a cost of 13.2%. The firm faces a tax rate of 25%. What will be the WACC for this project? ________________(Note: Round your intermediate calculations to three decimal places.)

Consider the case of Kuhn Co. Kuhn Co. is considering a new project that will require an initial investment of $20 million. It has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. Kuhn has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1555.38. The yield on the company’s current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividend of $8 at a price of $92.25 per share.

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $1.36 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 25%. What will be the WACC for this project? ______________(Note: Round your intermediate calculations to two decimal places.)

Smallville Bank has the following balance sheet, rates earned on its assets, and rates paid on its liabilities.

If the bank earns $120,000 in noninterest income, incurs $80,000 in noninterest expenses, and pays $2,500,000 in taxes, what is its net income? (Enter your answer in dollars, not thousands of dollars.

You are evaluating a project that will cost $ 547 ,000​, but is expected to produce cash flows of $ 127,000 per year for 10 ​years, with the first cash flow in one year. Your cost of capital is 10.7 % and your​ company's preferred payback period is three years or less.

a. What is the payback period of this​ project?

b. Should you take the project if you want to increase the value of the​ company?

If you want to increase the value of the company you?(will not or will)

take the project since the NPV is? (negative or positive)

DFB, Inc. expects earnings next year of $ 5.49 per​ share, and it plans to pay a $ 3.55 dividend to shareholders​ (assume that is one year from​ now). DFB will retain $ 1.94 per share of its earnings to reinvest in new projects that have an expected return of 14.6 % per year. Suppose DFB will maintain the same dividend payout​ rate, retention​ rate, and return on new investments in the future and will not change its number of outstanding shares. Assume next dividend is due in one year.

a. What growth rate of earnings would you forecast for​ DFB?

b. If​ DFB's equity cost of capital is 11.4 % what price would you estimate for DFB​ stock?

c. Suppose instead that DFB paid a dividend of $ 4.55 per share at the end of this year and retained only $ 0.94 per share in earnings. That​ is, it chose to pay a higher dividend instead of reinvesting in as many new projects. If DFB maintains this higher payout rate in the​ future, what stock price would you estimate for the firm​ now? Should DFB raise its​ dividend?

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 8%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation

Stock Funds (S) 17% 30%

Bond Funds 11 22

The correlation between the fund returns is 0.10. a-1. What are the investment proportions in the minimum-variance portfolio of the two risky funds. (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.) a-2. What is the expected value and standard deviation of its rate of return? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.)

Risky Cash Flows

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $8,000 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:

BPC has decided to evaluate the riskier project at a 11% rate and the less risky project at a 9% rate.

1. What is the expected value of the annual net cash flows from each project? Do not round intermediate calculations. Round your answers to nearest dollar.

   	Project A	Project B
   Net cash flow	$	$

   
   What is the coefficient of variation (CV)? Do not round intermediate calculations. (Hint: σ_B=$6,158 and CV_B=$0.78.)

   	σ (to the nearest whole number)	CV (to 2 decimal places)
   Project A	$
   Project B	$

2. 
   
3. What is the risk-adjusted NPV of each project? Do not round intermediate calculations. Round your answer to the nearest dollar.

   Project A		$
   Project B		$

4. 
   
5. If it were known that Project B is negatively correlated with other cash flows of the firm whereas Project A is positively correlated, how would this affect the decision?
   This would tend to reinforce the decision to -Select-acceptreject Project B.
   
   If Project B's cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?
   -Select-YesNo

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 8%. The probability distribution of the risky funds is as follows:

Expected Return Standard Deviation

Stock Funds (S) 24% 30%

Bonds Funds (B) 12 19

The correlation between the fund returns is 0.13. Solve numerically for the proportions of each asset and for the expected return and standard deviation of the optimal risky portfolio.

Portfolio invested in stocks?

Portfolio invested in bonds?

Expected return?

Standard Deviation?

(Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.)

CASH CONVERSION CYCLE

Parramore Corp has $14 million of sales, $3 million of inventories, $4 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 6% rate. Assume 365 days in year for your calculations. Do not round intermediate steps.

1. What is Parramore's cash conversion cycle (CCC)? Do not round intermediate calculations. Round your answer to two decimal places.
     days
2. 
   
3. If Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold, what would be the new CCC? Do not round intermediate calculations. Round your answer to two decimal places.
     days
4. 
   
5. How much cash would be freed up, if Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.
   $
6. 
   
7. By how much would pretax profits change, if Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.
   $

NOK Plastics is considering the acquisition of a new plastic injection-molding machine to make a line of plastic fittings. The cost of the machine and dies is $125,000. Shipping and installation is another $8,000. NOK estimates it will need a $10,000 investment in net working capital initially, which will be recovered at the end of the life of the equipment. Sales of the new plastic fittings are expected to be $350,000 annually. Cost of goods sold are expected to be 50% of sales. Additional operating expenses are projected to be $115,000 per year over the machine’s expected 5-year useful life. The machine will depreciated using a 5-year MACRS class life. The equipment will be sold at the end of its useful life (5 years) for $35,000. The tax rate is 25% and the relevant discount rate is 15%. Calculate the net present value (NPV), internal rate of return (IRR), payback period (PB), and profitability index (PI) and state whether the project should be accepted.

Use the data for Starbucks​ (SBUX) and Google​ (GOOG)

to answer the following​ questions:

a. What is the return for SBUX over the period without including its​ dividends? With the​ dividends?

b. What is the return for GOOG over the​ period?

c. If you have 30% of your portfolio in SBUX and 70% in​ GOOG, what was the return on your portfolio excluding​ dividends?

a. What is the return for SBUX over the period without including its​ dividends?

The return without the dividends is? (Round to two decimal​ places.)

: A firm is considering an investment in a new machine with a price of $18 million to replace its existing machine. The current machine has a book value of $6 million and a market value of $4.5 million. The new machine is expected to have a four-year life, and the old machine has four years left in which it can be used. If the firm replaces the old machine with the new machine, it expects to save $6.7 million in operating costs each year over the next four years. Both machines will have no salvage value in four years. If the firm purchases the new machine, it will also need an investment of $250,000 in net working capital. The required rate of return on the investment is 10 percent, and the tax rate is 39 percent. What are the NPV and IRR of the decision to replace the old machine? Show formulas in Excel please

As of 2019 where are Bethany McLean, Cliff Baxter, Andrew Fastow, Jeff Skilling, Sherron Watkins, Lou Pai and Kenneth Lay now?

In your opinion what was the one most outrageous thing that Enron did?