...Final Exam CorporateFinance FINC 650 1. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting? a. b. c. d. e. Long-term debt. Common stock. Short-term debt used to finance seasonal current assets. Preferred stock. All of the above are considered capital components for WACC and capital budgeting purposes.
2. A company has a capital structure which consists of 50 percent debt and 50 percent equity. Which of the following statements is most correct? a. b. c. d. The cost of equity financing is greater than the cost of debt financing. The WACC exceeds the cost of equity financing. The WACC is calculated on a before-tax basis. The WACC represents the cost of capital based on historical averages. In that sense, it does not represent the marginal cost of capital. e. The cost of retained earnings exceeds the cost of issuing new common stock.
3. Which of the following statements is most correct? a. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed. b. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt. c. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least rs, it should pay these funds to its stockholders and let them invest directly in other assets...

...Advanced CorporateFinance I SS 2012
Problem Set 1 Valuing Cash Flows
Problem Set 1
Valuing Cash Flows
Exercise 1 (Ex. 11.2 - 11.6 GT): Assume that Marriott’s restaurant division has the following joint distribution with the market return: Market Scenario Bad Good Great .25 .50 .25 Probability Market Return (%) -15 5 25 YR 1. Cash Flow Forecast $40 million $50 million $60 million
Assume also that the CAPM holds. 11.2 Compute the expected year 1 restaurant cash ﬂow for Marriott. 11.3 Find the covariance of the cash ﬂow with the market return and its cash ﬂow beta. 11.4 Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, ﬁnd the certainty equivalent of the year 1 cash ﬂow. What are the advantages and disadvantages of using such historical data for market inputs as opposed to inputs from a set of scenarios, like those given in the table above exercise 11.2? 11.5 Discount your answer in exercise 11.4 at a risk-free rate of 4 percent per year to obtain the present value. 11.6 Explain why the answer to exercise 11.5 diﬀers from the answer in Example 11.2.
1
Advanced CorporateFinance I SS 2012
Problem Set 1 Valuing Cash Flows
Exercise 2 (Ex. 13.1 - 13.7 GT):) Exercises 13.1 - 13.7 make use of the following data: In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation....

...costs are 10 percent. The cost of preferred stock is 9 percent and the cost of debt is 7 percent. (Assume debt and preferred stock have no flotation costs.) What is the weighted average cost of capital at the firm’s optimal capital budget?
6. Lamonica Motors just reported earnings per share of $2.00. The stock has a price earnings ratio of 40, so the stock’s current price is $80 per share. Analysts expect that one year from now the company will have an EPS of $2.40, and it will pay its first dividend of $1.00 per share. The stock has a required return of 10 percent. What price earnings ratio must the stock have one year from now so that investors realize their expected return?
7. Heavy Metal Corp. is a steel manufacturer that finances its operations with 40 percent debt, 10 percent preferred stock, and 50 percent equity. The interest rate on the company’s debt is 11 percent. The preferred stock pays an annual dividend of $2 and sells for $20 a share. The company’s common stock trades at $30 a share, and its current dividend (D0) of $2 a share is expected to grow at a constant rate of 8 percent per year. The flotation cost of external equity is 15 percent of the dollar amount issued, while the flotation cost on preferred stock is 10 percent. The company estimates that its WACC is 12.30 percent. Assume that the firm will not have enough retained earnings to fund the equity portion of its capital budget. What is the company’s tax rate?
8....

...coupon rate could cause a serious depreciation of funds if this method is used
because; the coupon rate uses the face value of the bond, in order to compute the
bond(s) value, and does not take into consideration the price at which the issue of
this bond was or the redemption value of the bond. The Yield to maturity (YTM)
method is better to use because the Yield to maturity (YTM) method incorporates
all fluctuations and the issuing expenses, if any. Thus, the Yield to maturity
(YTM) method is a better method to use, and not the coupon rate as the required
return for debt.
2. Compute the cost of common equity using the CAPM model. For beta, use the average
beta of three selected competitors. You may obtain the betas from Yahoo Finance.
Assume the risk free rate to be 3% and the market risk premium to be 4%.
Risk free Rate 3%
Market risk premium, MRP 4%
Competitors Beta As on October 6, 2010
Dendreon Corp .65 http://finance.yahoo.com/q/ks?s=RTN+Key+Statistics
Douglas Emmet 1.40 http://finance.yahoo.com/q/ks?s=BA+Key+Statistics
Raytheon Company
Common Stock
1.07 http://finance.yahoo.com/q/ks?s=LMT+Key+Statistics
Average Beta 1.04
a. What is the cost of common equity? (5 pts)
The cost of common equity is the annual rate of return that a company, business,
investor, and so on expect to earn when they are investing in shares of a
company.
The cost of common equity is the risk free rate plus (MRP * Beta) = 7.16%
.65 + 1.40 + 1.07= 3.12...

...investors have to compensate for the undersized horizon by adding value elsewhere in the model. The prime candidate for the value dump is the continuing, or terminal, value. The result is often a completely non-economic continuing value. This value misallocation leaves both parts of the model—the forecast period and continuing value estimate—next to useless.
Some investors swear off the DCF model because of its myriad assumptions. Yet they readily embrace an approach that packs all of those same assumptions, without any transparency, into a single number: the multiple.
Many companies require over ten years of value-creating cash flows to justify their stock prices. Ideally, the explicit forecast period should capture at least one-third of corporate value with clear assumptions about projected financial performance.
While the range of possible outcomes certainly widens with time, we have better analytical tools to deal with an ambiguous future than to place an uncertain multiple on a more certain near-term earnings per share figure. We address the uncertainty issue below.
In reference to the hostile bid of €694 million, what the free cash flow model tells us is that the company is valued around €788 million. The hostile bid from Ryan air is massively undervalued. We must bear in mind that this is only one model and for a complete analysis, we must look at different models and compare.
Section B
Analysts like to use the free cash flow valuation model...

...constant growth dividend valuation model for ordinary shares, and explain the terms in the model. (3 marks)
l) What are the assumptions behind g = rb? (3 marks)
m) Which group of investors prefer capital gains to dividends and why? (3 marks)
n) If a clientele effect exists, what does it imply for dividend policy? (3 marks)
Total Mark (40 marks)
Section B: Answer All Parts of the Question
Q2 (a)
You have just secured your first job as a financial analyst after successfully completing your postgraduate study. Your first assignment involves demonstrating a thorough grasp of Mean-Variance Analysis and Portfolio Theory, which coincidentally was your most favourite topic in Principles of Modern Finance module. Before your arrival, a more experienced analyst had been working on two projects for a client, and has already estimated the risk and return characteristics of two projects as well as the correlation coefficient between the projects. These are given in the table below:
Project 1 Project 2
Expected return 12% 20%
Risk (std dev) 3% 7%
Correlation between the
Project = + 0.1
The client plans to invest 80% of its available funds in Project 1 and 20% in Project 2.
Following your employment, the senior analyst has been moved to a new and more challenging task and you have been asked to complete the assignment as indicated below.
Required:
(i) To...

...year is (170,000) : This project might have more than one IRR.
CH. 14
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After-tax cost of debt = Yield (1-tax rate). NPV - PV(inflows) – Initial outlay – Floatation costs. Cost of equity = dividend yield + growth rate
Quiz
Valid issue in implementing the dividend growth model? The model is based upon the assumption that dividends are expected to grow at a constant rate forever. In order to maximize firm value, management should invest in new assets when cash flows from the assets are discounted at the firm’s COST OF CAPITAL and result in positive NPV. The most expensive source of capital is usually NEW COMMON STOCK. Many corporatefinance professionals favor the CAPM for determining the cost of equity. Why? The variables in the model that apply to public corporations are readily available from public sources. Which is true? A firm should utilize a weighted average cost of capital for evaluating investment decisions rather than an arithmetic average of cost of capital. The cost of capital is? All of the above. Which describes a firm’s cost of capital? The rate of return that must be earned on its investments in order to satisfy the firm’s investors. Which reason causes bonds to be less expensive for of capital for a public firm than the issuance of common stock? Bondholders bear less risk than common stock holders. Which is NOT...

...Hi, I need an Introduction and conclusion for this case. Please refer some company background and data that base on the case for introduction (I put the link for this case on other attachment). I already got the answer for question 1-3. Need a summary of my solution for conclusion.
About 2 pages total.
Question :
Nike, Inc.: Cost of Capital
1 What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not?
2 If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions.
3 Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method?
Introduction :
Solution
Question 1 :
The WACC is the weighted average cost of capital for a firm. It is comprised of three components: cost of equity, cost of debt, and cost of preferred stock. The three are then added with the weights factored in to get the value of the WACC. The WACC is used by firms in their capital budgeting to discount cash flows. It can be seen as the opportunity cost for the firm to use their capital elsewhere. Generally a lower WACC is better, as it discounts cash flows to a lesser degree, leading to a higher chance of a positive NPV which will add value to the firm.
In her calculation of the WACC Cohen used the book value of...