Chapter 14Problems 1-26

Input boxes in tanOutput boxes in yellowGiven data in blueCalculations in redAnswers in green

NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.To install these, click on the Office button then "Excel Options," "Add-Ins" and select"Go." Check "Analyis ToolPak" and "Solver Add-In," then click "OK."

NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.

Chapter 14Question 1

Input Area:

Dividend per share $ 2.40 Growth rate 5.50%Stock price $ 52

Output Area:

Cost of equity 10.37%

Chapter 14Question 2

Input Area:

Beta 1.05 Risk-free rate 5.3%Market return 12%

Output Area:

Cost of equity 12.34%

Chapter 14Question 3

Input Area:

Beta 0.85 Market risk premium 8.0%T-bill rate 5.0%Dividend per share $ 1.60 Growth rate 6%Stock price $ 37

Output Area:

11.80%10.58%11.19%

RE: CAPMRE: DCFRE

Chapter 14Question 4

Input Area:

Current dividend $ 1.43 Dividends:Year 1 $ 1.05 Year 2 $ 1.12 Year 3 $ 1.19 Year 4 $ 1.30 Stock price $ 45.00

Output Area:

Arithmetic average:

6.67%

6.25%

9.24%

10.00%g 8.04%

11.47%

Geometric average:Geometric growth 8.03%

11.46%

g1

g2

g3

g4

RE

RE

Chapter 14Question 5

Input Area:

Dividend per share $ 6.00 Stock price $ 96.00

Output Area:

6.25%RP

Chapter 14Question 6

Input Area:

Settlement 01/01/08Maturity 01/01/23Price (% of par) 107 Coupon rate 7%Payments per year 2 Tax rate 35%

Output Area:

Pretax cost 6.27%Aftertax cost of debt 4.08%

Chapter 14Question 7

Input Area:

Settlement 01/01/08Maturity 01/01/31Coupon rate 8%Price (% of par) 95 Payments per year 2 Tax rate 35%

Output Area:

a. Pretax cost of debt 8.50%b. Aftertax cost of debt 5.52%c. The after-tax rate is more relevant because

that is the actual cost to the company.

Chapter 14Question 8

Input Area:

Book value of debt issue (1) $ 80,000,000 Second issueSettlement date 01/01/08Maturity date 01/01/15Annual coupon rate 0%Coupons per year 2 Bond price (% of par) 61 Tax rate 35%Book value debt issue (2) $35,000,000

Output Area:

Book value of debt $ 115,000,000

Market value of first bond $ 76,000,000

Market value of second bond $ 21,350,000

Market value of debt $ 97,350,000

Pretax cost of second issue 7.188%

Aftertax cost of second issue 4.672%

Aftertax cost of debt 5.34%

Chapter 14Question 9

Input Area:

Common stock 60%Preferred stock 5%Debt 35%Cost of equity 14%Cost of preferred stock 6%Cost of debt 8%Tax rate 35%

Output Area:

a. WACC 10.52%b. Since interest is tax deductible and dividends

dividends are not, we must look at the aftertax cost of debt, 5.20%Hence, on an aftertax basis, debt is cheaperthan the preferred stock.

Chapter 14Question 10

Input Area:

Debt-to-equity ratio 0.65 Cost of equity 15%Cost of debt 9%Tax rate 35%

Output Area:

WACC 11.40%

Chapter 14Question 11

Input Area:

WACC 8.90%Cost of equity 12%Cost of debt 7.9%Tax rate 35%

Output Area:

D/E 0.8234

Chapter 14Question 12

Input Area:

Shares outstanding 11,000,000 Market price per share $ 68 Book value per share $ 6 Bond IBook value $ 70,000,000 Coupon rate 7.00%Bond price (% of par) 93.0 Settlement date 01/01/08Maturity date 01/01/29Payments per year 2 Bond IIBook value $ 55,000,000 Coupon rate 8.00%Bond price (% of par) 104.0 Settlement date 01/01/08Maturity date 01/01/14Payments per year 2

Output Area:

a. BV(E) $ 66,000,000 BV(D) $ 125,000,000 V $ 191,000,000

E/V 0.3455 D/V 0.6545

b. MV(E) $ 748,000,000 MV(D) $ 122,300,000 V $ 870,300,000

E/V 0.8595 D/V 0.1405

The market value weights are more relevantbecause they represent a more currentvaluation of the debt and equity.

Chapter 14Question 13

Input Area:

Shares outstanding 11,000,000 Market price per share $ 68 Book value per share $ 6 Bond IBook value $ 70,000,000 Coupon rate 7.00%Bond price (% of par) 93.0 Settlement date 01/01/08Maturity date 01/01/29Payments per year 2 Bond IIBook value $ 55,000,000 Coupon rate 8.00%Bond price (% of par) 104.0 Settlement date 01/01/08Maturity date 01/01/14Payments per year 2

Dividend $ 4.10 Growth rate 6%Tax rate 35%

Output Area:

12.39%Pretax cost of bond I 7.676%Aftertax cost of bond I 4.990%Pretax cost of bond II 7.168%Aftertax cost of bond II 4.659%Market value of debt $ 122,300,000 Weight of bond I 0.5323 Weight of bond II 0.4677 Company's aftertax

RE

cost of debt 4.835%

WACC 11.33%

Chapter 14Question 14

Input Area:

Debt-equity ratio 1.05 WACC 9.40%Tax rate 35%

a. Cost of equity 14%b. Aftertax cost of debt 6.8%

Output Area:

a. R(D) 7.72%

b. R(E) 12.13%

Chapter 14Question 15

Input Area:

Tax rate 35%DebtBonds outstanding 8,000 Settlement date 01/01/08Maturity date 01/01/28Annual coupon rate 6.50%Coupons per year 2 Bond price (% of par) 92

Common stock Shares outstanding 250,000 Beta 1.05 Share price $ 57

Preferred stock outstandingShares outstanding 15,000 Coupon rate 5.00%Share price $ 93

MarketMarket risk premium 8.00%Risk-free rate 4.50%

Output Area:

Market value of debt $ 7,360,000 Market value of equity $ 14,250,000 Market value of preferred $ 1,395,000 Market value of firm $ 23,005,000

Pretax cost of debt 7.26%Aftertax cost of debt 4.72%

Cost of equity 12.90%

Cost of preferred 5.38%

WACC 9.83%

Chapter 14Question 16

Input Area:

DebtBonds outstanding 105,000 Settlement date 01/01/08Maturity date 01/01/23Annual coupon rate 7.50%Coupons per year 2 Bond price (% of par) 93

Common stock Shares outstanding 9,000,000 Beta 1.25 Share price $ 34

Preferred stock outstandingShares outstanding 250,000 Coupon rate 6.00%Share price $ 91

MarketMarket risk premium 8.50%Risk-free rate 5.00%Tax rate 35%

Output Area:

a. Market value of debt $ 97,650,000 Market value of equity $ 306,000,000 Market value of preferred $ 22,750,000 Market value of firm $ 426,400,000

D/V 0.2290 E/V 0.7176 P/V 0.0534

b. For projects equally as risky as the firm itself, the WACC should be used as the discount rate.

Pretax cost of debt 8.33%Aftertax cost of debt 5.41%

Cost of equity 15.63%

Cost of preferred 6.59%

WACC 12.80%

Chapter 14Question 17

Input Area:

Project Beta Project E(R)W 0.80 10%X 0.90 12%Y 1.45 13%Z 1.60 15%

Firms cost of capital 11%Market expected return 11%T-bill rate 5%

Output Area:

a. ProjectW LowerX HigherY HigherZ Higher

b. Project CAPM E(R) Accept/RejectW 9.80% AcceptX 10.40% AcceptY 13.70% RejectZ 14.60% Accept

c. ProjectW Incorrectly RejectedX Correctly AcceptedY Incorrectly AcceptedZ Correctly Accepted

Chapter 14Question 18

Input Area:

Cost $ 20,000,000 Debt-equity ratio 0.75 Equity flotation cost 8%Debt flotation cost 5%

Output Area:

a. He should look at the weighted average flotation cost, not just the debt cost.

b. 6.71%

c. Cost $ 21,439,510 Even if the specific funds are actually beingraised completely from debt, the flotation costs and hence true investment cost shouldbe valued as if the firm's target capital structure is used.

fT

Chapter 14Question 19

Input Area:

Cost $ 45,000,000

Capital structure:Common stock 65%Preferred stock 5%Debt 30%

Flotation cost:Common stock 9%Preferred stock 6%Debt 3%

Output Area:

0.071

Cost $ 48,413,125

fT

Chapter 14Question 20

Input Area:

Aftertax cash savings $ 2,700,000 Growth rate 4%Debt-equity ratio 0.90 Cost of equity 13%Aftertax cost of debt. 4.8%Adjustment factor 2%

Output Area:

WACC 9.12%Project discount rate 11.12%Breakeven cost $ 37,943,787 The project should only be undertaken if its cost is less than $ 37,943,787

Chapter 14Question 21

Input Area:

Projected cost $ 15,000,000 Flotation costs $ 850,000 Equity flotation cost 7%Debt flotation costs 3%

Output Area:

Total costs $ 15,850,000 f(T) 5.36%D/E 0.6929

Chapter 14Question 22

Input Area:

Bond Coupon Rate Price Quote Maturity Face value1 7.00% 103.00 5 years $ 40,000,000 2 8.50% 108.00 8 years $ 35,000,000 3 8.20% 97.00 15 1/2 years $ 55,000,000 4 9.80% 111.00 25 years $ 50,000,000

Tax rate 34%Payments per year 2

Output Area:

Market value Weight1 $ 41,200,000 0.2193 2 $ 37,800,000 0.2012 3 $ 53,350,000 0.2840 4 $ 55,500,000 0.2954

Total $ 187,850,000

Bond 1 Bond 2 Bond 3 Bond 4Settlement date 01/01/08 01/01/08 01/01/08 01/01/08Maturity date 01/01/13 01/01/16 07/01/24 01/01/33Annual coupon rate 7.00% 8.50% 8.20% 9.80%Coupons per year 2 2 2 2Face value (% of par) 103.00 108.00 97.00 111.00Bond price (% of par) 100.00 100.00 100.00 100.00

Pretax cost 6.29% 7.17% 8.54% 8.71%Aftertax cost 4.15% 4.73% 5.64% 5.75%

Pretax cost of debt 7.82%Company's aftertax cost of debt 5.16%

Chapter 14Question 23

Input Area:

Beta 1.50 Dividend per share $ 0.80 Growth rate 5.0%Market return 12.0%T-bill rate 5.5%Stock price $ 61.00

Output Area:

a. 6.38%

b. 15.25%

c. When using the dividend growth model or the CAPM, you must remember that bothare only estimates for the cost of equity.Additionally, and perhaps more importantly,each method of estimating the cost of equity depends upon different assumptions.

RE: DCF

RE: CAPM

Chapter 14Question 24

Input Area:

Debt-to-equity ratio 0.70 Projected cost $ 45,000,000 Aftertax cash flows $ 6,200,000 Equity floatation costs 8%Required return 14%Debt floatation costs 4%Coupon rate 8%Target ratio A/P to LTD 20%A/P floatation costs 0%Tax rate 35%

Output Area:

WACC 10.76%Floatation costs 6.08%Project cost $ 47,912,317 NPV $ 9,719,777

Chapter 14Question 25

Input Area:

Debt-to-equity ratio 1.20 Projected cost $ 145,000,000 Equity floatation costs 8%Debt floatation costs 3.50%Percentage equity raised internally 0%

Output Area:

54.55%45.45%

Floatation costs 5.55%

Project cost $ 153,512,993

wD

wE

Chapter 14Question 26

Input Area:

Land price $ 4,000,000 Current land value $ 5,100,000 Land value in 5 years $ 6,000,000 Plant & Equipment cost $ 35,000,000

DebtBonds outstanding 240,000 Settlement date 01/01/08Maturity date 01/01/28Annual coupon rate 7.50%Coupons per year 2 Face value (% of par) 100 Bond price (% of par) 94

Common stock Shares outstanding 9,000,000 Beta 1.20 Share price $ 71.00

Preferred stock outstandingShares outstanding 400,000 Coupon rate 5.50%Share price $ 81.00

MarketMarket risk premium 8.00%Risk-free rate 5.00%

Equity floatation cost 8.00%Preferred floatation cost 6.00%Debt floatation cost 4.00%Tax rate 35%Net working capital $ 1,300,000 Does the NWC requirefloatation costs (Yes/No) No

b. Adjustment factor 2%c. Life of plant (years) 8

Life of project (years) 5 Plant salvage value $ 6,000,000

d. Annual fixed costs $ 7,000,000 # RDS manufactured 18,000 Sale price per RDS $ 10,900 Variable costs per RDS $ 9,400

Output Area:

Market value of debt $ 225,600,000 Market value of equity $ 639,000,000 Market value of preferred $ 32,400,000 Market value of firm $ 897,000,000

D/V 0.2515 E/V 0.7124 P/V 0.0361

a. Floatation costs 0.0692 The cost of the land 3 years ago is a sunk cost and is irrelevant.Land $ (5,100,000)Plant (including floatation) $ (37,602,765)Net working capital $ (1,300,000)

$ (44,002,765)

b. Pretax cost of debt 8.11%Aftertax cost of debt 5.27%Cost of equity 14.60%Cost of preferred 6.79%WACC 11.97%

Discount rate for project 13.97%

c. Book value in year 5 $ 13,125,000 Aftertax salvage value $ 8,493,750

d. Sales $ 196,200,000 Variable costs $ (169,200,000)Fixed costs $ (7,000,000)Depreciation $ (4,375,000)EBIT $ 15,625,000 Taxes $ (5,468,750)Net income $ 10,156,250 Depreciation $ 4,375,000 Operating cash flow $ 14,531,250

e. Accounting breakeven 7,583

f. Year Cash Flow 0 $ (44,002,765)1 $ 14,531,250 2 $ 14,531,250 3 $ 14,531,250 4 $ 14,531,250 5 $ 30,325,000

IRR 25.25%

NPV $ 14,130,713.81