1. Foggy Bottom Pharmaceuticals has $14 million in debt and $86 million in equity. Its tax rate is 32%, cost of debt 8%, and beta 1.3. The riskless rate is 4% and the expected return on the market 11%. Foggy Bottom would like to start a newspaper using its existing capital. L’Enfant Times is a daily newspaper. L’Enfant has $10 million in debt and $40 million in equity, with tax rate of 33% and beta 1.8. Find the required rate of return for Foggy Bottom in the new venture. 14.51%
2. Consider the financial information of Farragut West Hotels and McPherson Inns, the two hotel chains.
Company |
Debt/Assets |
β |
Cost of debt |
Tax rate |
Farragut West Hotels |
40% |
1.25 |
14% |
31% |
McPherson Inns |
28% |
? |
9% |
33% |
At present, the risk-free rate is 3.5% and the expected return on the market 13%. Find the weighted average cost of capital for McPherson. 11.59%
3. The following table provides the financial information of two companies in different businesses, with the dollar amounts in millions:
Company |
Debt |
Cost of debt |
Equity |
Cost of equity |
Tax rate |
Business |
King Street Co. |
$40 |
10% |
$135 |
14% |
32% |
Chemicals |
Crystal City Co. |
$10 |
8% |
$80 |
12% |
31% |
Retail stores |
At present, the risk-free rate is 3% and the expected return on the market 10%. If King Street Company wants to start a retail store chain as a side business, using its existing capital, what is the minimum acceptable rate of return on the new venture? From your analysis, can you deduce which is the riskier business, chemicals or retail stores? 11.55%, chemicals
4. Braddock Company has beta 1.5, debt/assets ratio 30%, and tax rate 30%. The cost of debt for Braddock is 8%, and of equity 15%. The riskless rate is 5%. Find the WACC of Braddock. If its debt/assets ratio is increased to 32% while its cost of debt remains unchanged, what is the new WACC? Which leverage ratio is better? Answer not given
5. Van Dorn Company has $155 million of bonds outstanding, with a coupon of 4.5%, selling at 85. It has 2 million shares of $2.50 preferred stock and 30 million shares of common stock. Van Dorn has EBIT of $95 million this year, and it has income tax rate of 30%. Van Dorn must also pay a principal payment of $14 million to the bondholders. The company has decided to have a dividend payout ratio of 25%. What dividend should Van Dorn declare on the common stock per share? 35.51¢
6. Huntington Company expects to have $100 million in EBIT next year, with standard deviation $7 million. The company has $140 million in long-term bonds with coupon 7%, and it has to pay $6 million in preferred dividends. Huntington has dividend payout ratio 45%, and 30 million shares of common stock. The income tax rate of the company is 35%. Find the probability that the dividend next year is more than 83¢ per share. 27.62%
7. Eisenhower Ave Corporation has the following capital structure: $110 million in bonds, selling at par with coupon 6%; 50 million shares of common stock, priced at $45 each; and 1.2 million shares of preferred stock with an annual dividend of $3.50 each. Next year, the company expects to have EBIT of $90 million out of which it wants to keep $14 million in retained earnings. The tax rate of the company is 33%. Find the dividend that it should declare on the common stock. What is the dividend yield of this stock? 75.356¢ per share, 1.675%
8. Anacostia Company follows the residual theory of dividends. It has 7 million shares of common stock, and it maintains its optimal debt/assets ratio at 32%. Its EBIT next year is expected to be $18 million, with a standard deviation of $3 million. The income tax rate of Anacostia is 32% and it has to pay $3 million in interest. It would like to finance $12 million in new projects from retained earnings and new borrowings. Find the probability that it will be able to give a dividend of at least 75¢ next year. Answer not given