Question
29. TPP Inc., which owns and operates a chain of tattoo and piercing parlors, was founded 10 years ago. It has been profitable for the
29. TPP Inc., which owns and operates a chain of tattoo and piercing parlors, was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated it plans to pay a $0.30 dividend 2 years from today, then to increase it at a relatively rapid rate for several years and then to increase it at a constant rate of 3.0% thereafter, as shown in the table below. Managements credibility with investors is high and it is believed the current price of the stock, $19, represents fair value i.e. the market is in equilibrium. What is the expected rate of return on the common stock?
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
Growth Rates | 40.0% | 30.0% | 20.0% | 10.0% | 6.5% | 3.0% |
a. 5.00%
b. 6.16%
c. 6.24%
d. 6.27%
e. 7.54%
30. Weimar Inc. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT?
a. While the decision to use just one WACC will result in accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant's recommendation, this should not affect the firm's intrinsic value.
b. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time.
c. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm's intrinsic value over time.
d. The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time.
e. The decision not to risk-adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm's capital structure but it will not affect its intrinsic value.
31. A firm plans to issue a $1,000 par value, 20-year non-callable bond with a 7.00% coupon rate paid semiannually. The firm forecasts its proceeds after discounting the bonds and flotation costs will be 98.795. The company's marginal tax rate is currently 35%, but Congress is considering a change in the corporate tax rate to 15%. By how much would the effective cost of the debt change if the new tax rate is adopted?
a. Decrease of 0.70%
b. Decrease of 0.7114%
c. Increase of 0.7114%
d. Increase of 1.40%
e. Increase of 1.4228%
32. Wettin A.G. is issuing new 20-year bonds that have warrants attached. If not for the attached warrants, the bonds would carry an 11% annual interest rate. However, with the warrants attached the bonds will pay an 8% annual coupon. The bonds will be issued in Europe where coupons are traditionally paid annually. There are 30 warrants attached to each bond, which have a par value of 1000. What is the value of the straight-debt portion of the bonds?
a. 652.55
b. 686.89
c. 723.05
d. 761.10
e. 799.16
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