Question 1: The Connors Company's last dividend was $1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (rs) is 12%. What is Connors' current stock price?
- $54.91
- $56.82
- $58.15
- $60.07
- $62.87
Question 2: Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital. You have been provided with the following data: D0 = $1.20; P0 = $40.00; and g = 7% (constant). Based on the DCF approach, what is Brown's cost of equity from retained earnings?
- 10.06%
- 10.21%
- 10.37%
- 10.54%
- 10.68%
Question 3: You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm's WACC?
- 8.25%
- 8.38%
- 8.49%
- 8.61%
- 8.76%
Question 4: Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a 12% WACC. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project.
Question 5: Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of projects X and Y. Which of the following statements is CORRECT?
Safeco/Risco's WACC, as a result of the merger, would be 10%.
If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will become riskier over time.
After the merger, Safeco/Risco should select Project Y but reject Project X.
Question 6: Blanchford Enterprises is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year: 0 1 2 3
Cash flows: -$1,000 $450 $450 $450
16.20%
16.65%
17.10%
17.55%
18.00%