# BUSINESS

Question

This case assignment is focused on Bond valuation and stock valuation concepts and procedures.

1. You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of common from retained earnings is 11.25%, and the tax rate is 40%. The firm will not be issuing any new common stock. What is Quigley’s WACC?

2. You were recently hired by Scheuer Media Inc. to estimate its cost of common equity. You obtained the following data: D_{1} = $1.75; P_{0} = $42.50; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock?

3. S. Bouchard and Company hired you as a consultant to help estimate its cost of common equity. You have obtained the following data: D_{0} = $0.85; P_{0} = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the DCF approach, by how much would the cost of common from retained earnings change if the stock price changes as the CEO expects?

4. Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders’ required rate of return, r_{s}, is 12.25%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures.

5. Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm’s noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of common stock, and it does not expect to issue any new shares. What is its WACC?

6. Current Design Co. is considering two mutually exclusive, equally risky, and not repeatable projects, S and L. Their cash flows are shown below. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what’s the chosen NPV versus the maximum possible NPV? Note that (1) “true value” is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.

WACC: | 7.50% | ||||

Year | 0 | 1 | 2 | 3 | 4 |

CF_{S} |
-$1,100 | $550 | $600 | $100 | $100 |

CF_{L} |
-$2,700 | $650 | $725 | $800 | $1,400 |

7. Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used.

WACC: | 10.25% | ||||

Year | 0 | 1 | 2 | 3 | 4 |

CF_{S} |
-$2,050 | $750 | $760 | $770 | $780 |

CF_{L} |
-$4,300 | $1,500 | $1,518 | $1,536 | $1,554 |

8. Shannon Co. is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?

WACC: | 10.00% | ||||

Year | 0 | 1 | 2 | 3 | 4 |

Cash flows | -$950 | $525 | $485 | $445 | $405 |

9. Westwood Painting Co. is considering a project that has the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less than the WACC (and even negative), in which case it will be rejected.

WACC: | 12.25% | ||||

Year | 0 | 1 | 2 | 3 | 4 |

Cash flows | -$850 | $300 | $320 | $340 | $360 |

10. Last month, Standard Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project took place, the Federal Reserve changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV? Note that a project’s expected NPV can be negative, in which case it should be rejected.

Old WACC: | 10.00% | New WACC: | 11.25% | |

Year | 0 | 1 | 2 | 3 |

Cash flows | -$1,000 | $410 | $410 | $410 |