Question

Problem 12-23 Calculating the Cost of Equity [LO 1]

Pierce Industries stock has a beta of 1.26. The company just paid a dividend of $.76, and the dividends are expected to grow at 5.1 percent. The expected return on the market is 11.6 percent, and Treasury bills are yielding 5.1 percent. The most recent stock price is $81.25.

a. Calculate the cost of equity using the dividend growth model method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Cost of equity             %

b. Calculate the cost of equity using the SML method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Cost of equity             %

Problem 12-21 WACC and NPV [LO 4]

Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $5.6 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt–equity ratio of .55, a cost of equity of 13 percent, and an aftertax cost of debt of 6.4 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +1 percent to the cost of capital for such risky projects.

Calculate the WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
WACC             %

What is the maximum cost the company would be willing to pay for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
Present value            $

Problem 11-25 Portfolio Returns and Deviations [LO 1, 2]

Consider the following information on a portfolio of three stocks:

State of	Probability of			Stock A			Stock B			Stock C
Economy	State of Economy			Rate of Return			Rate of Return			Rate of Return
Boom		.15			.02			.32			.60
Normal		.55			.10			.12			.20
Bust		.30			.16		−	.11		−	.35

a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio’s expected return, the variance, and the standard deviation? (Do not round intermediate calculations. Round your variance answer to 5 decimal places, e.g., 32.16161. Enter your other answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Expected return		%
Variance
Standard deviation		%

b. If the expected T-bill rate is 3.75 percent, what is the expected risk premium on the portfolio? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Expected risk premium             %

Answer 1

Pierce Industries stock has a beta of 1.26. The company just paid a dividend of $.76, and the dividends are expected to grow at 5.1 percent. The expected return on the market is 11.6 percent, and Treasury bills are yielding 5.1 percent. The most recent stock price is $81.25.

a. Calculate the cost of equity using the dividend growth model method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
=0.76*1.051/81.25+5.1%=6.08%

b. Calculate the cost of equity using the SML method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
=5.1%+1.26*(11.6%-5.1%)=13.29%

Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $5.6 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt–equity ratio of .55, a cost of equity of 13 percent, and an aftertax cost of debt of 6.4 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +1 percent to the cost of capital for such risky projects.

Calculate the WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
=0.55/1.55*6.4%+1/1.55*13%=10.658%

What is the maximum cost the company would be willing to pay for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
=5.6/(10.658%+1%-3%)=64.68

P.S.: I am allowed to answer only 4 parts