1. Station WJXT is considering the replacement of its old fully depreciated sound mixer. Two new models are available. Mixer X has a cost of $216,600, a five-year expected life, and after-tax cash flows (including the tax shield from depreciation) of $68,200 per year. Mixer Y has a cost of $345,000, a ten-year life, and after-tax cash flows (including the tax shield from depreciation) of $83,400 per year. No new technological developments are expected. The discount rate is 12 percent. Should WJXT replace the old mixer, and, if so, with X or Y?

2. The Goodtread Rubber Company has the following two divisions.

(i) Tire Division -- which manufactures tires for new autos

Recap Division -- which manufactures recapping materials that are sold to independent recapping shops.

Since auto manufacturing moves up and down with the general economy, the Tire Division's earnings contribution to Goodtread's stock price is highly correlated with the returns on most other stocks. If the Tire Division was operated as a separate company the beta of its assets would be 1.60. The sales and earnings of the Recap Division, on the other hand, are not as cyclical since recap sales are high when people cannot afford to buy new tires. The beta of Recap's assets is 0.40. Approximately 75% of Goodtread's corporate assets are in the Tire Division and 25% in the Recap Division. Goodtread has a debt/equity ratio of 0.5. Its debt is risk free. Currently, the risk free rate is 5% and the expected return on the market portfolio is 12%. There are no taxes and the assumptions of the CAPM are satisfied.

(a) What is the required rate of return on Goodtread's stock?

(b) What discount rate should Goodtread use to evaluate capital budgeting projects? Explain your answer.

3. Western Airline has decided to raise $5M in new equity by means of a rights offering. They have decided to issue 50,000 new shares. The stock currently sells for a rights-on price of $150 per share. If the ex-rights price is expected to be $133.33 per share, answer the following questions assuming all the rights are exercised unless otherwise stated.

(a) What is the issue price?

(b) How many shares are currently outstanding (before the rights issue)?

(c) What percentage of the rights were actually exercised if the ex-rights price turns out to be $135.71?

(d) Suppose the firm anticipates that 30% of the rights will not be exercised. What should the issue price be if the other issue terms stay the same and the firm wants to raise the same amount of money?

4. If a firm borrows permanently $25 Million at an interest rate of 7%, what is the present value of the interest tax shield? If a firm borrows $25 Million for one year at an interest rate of 8%, what is the present value of the interest tax shield? (Assume the corporate tax rate T_c = 0.35)

5. A firm is proposing to undertake a scale expansion. It would cost $40 million and produce an expected cash flow of $5 million a year in perpetuity before it is taxed at the corporate rate of 34%. The firm is financed 40% by debt. The expected return on the firm's equity is 20% and the interest rate on its debt is 12%. What is the NPV of the project using the weighted average cost of capital?