c. What was the firms historical dividend growth rate using the point-to-point method? Using the linear regression method? 7. Use the bond-yield-plus-risk-premium method to estimate Aces cost of retained earnings. 8. Based on all the information available, what is your best estimate for ks? Explain how you decided what weight to give to each estimating technique. 9. What is your estimate of Aces cost of new common stock, ke? What are some potential weaknesses in the procedures used to obtain this estimate? 10. a. Compute Aces WACCs based on the companys target capital structure and construct the marginal cost of capital (MCC) schedule. How large could the companys capital budget be before it is forced to sell new common stock? Ignore depreciation at this point. b. Would the MCC schedule remain constant beyond the retained earnings break point, no matter how much new capital it raised? Explain. Again, ignore depreciation. c. How does depreciation affect the MCC schedule? If depreciation were simply ignored, would this affect the acceptability of proposed capital projects? Explain. 11. Should the corporate cost of capital as developed above be used for all projects? If not, what type of adjustments should be made?

Table 1 Ace Repair, Inc.: Income Statement for the Year Ended December 31, 1995 (In Thousands of Dollars) Net sales $400,467 Cost of goods sold 320,477 Gross profit $79,990 Admin and selling exp $34,040 Depreciation 4,080 Miscellaneous expenses 10,132 Total operating exp $48,252 EBIT $31,738 Interest on ST loans $3,016 Interest on LT debt 3,600 Total interest $6,616 Before-tax earnings $25,122 Taxes (40%) 10,049 Earnings bef. pref. div. $15,073 Preferred dividends 800 Net income available to common $14,273 Dividends on common stock $2,855 Additions to retained earnings $11,418 EPS $2.30 DPS $0.46 Table 2 Ace Repair, Inc.: Balance Sheet December 31, 1995 (In Thousands of Dollars) Assets Liabilities And Equities Cash and securities $5,000 Accounts payable $38,987 Accounts receivable 46,286 S-T bank loans 35,480 Inventory 74,065 Accruals 14,662 Current assets $125,351 Current liabilities $89,129 Land, buildings, plant, and equipment $106,463 Long-term bonds 40,000 Accumulated depreciation (13,388) Total liabilities $129,129 Net fixed assets $93,075 Preferred stock $10,000 Common stock 20,000 Retained earnings 59,297 Total common equity $79,297 Total assets $218,426 Total liab. and equity $218,426 Table 3 Selected Ratios, Ace Repair, Inc. Current ratio 1.41 times Quick ratio 0.58 times Total debt/total assets 59.1% Long-term debt/long-term capital 30.9% Times interest earned 4.80 times Inventory turnover 5.41 times Days sales outstanding 41.61 days Total assets turnover 1.83 times Profit margin 3.56% P/E ratio 13.26 times Market/book ratio 2.39 times Payout ratio 20.0% Table 4 Selected Data on Ace Repair, Inc.

1. The end-of-year bond quote on Aces long-term, semiannual bond as reported in the financial press is as follows: Bonds Cur Yld Vol Close Net Chg ACE 10s12 8.3 30 120.90 +1/2 These bonds will become callable in 3 years at a price of $1,100. 2. End-of-year quotes on Aces common and perpetual preferred stock were as follows: 52 Weeks Yld Vol Net Hi Lo Stock Sym Div % PE 100s Hi Lo Close Chg 31.5 26.5 Ace ACER 0.46 1.5 13.3 356 31 30 30 +1/2 110 98 Acepf ACEP 8.00 7.6 67 105 102 105 +3/4 3. End-of-year quotes on long-term treasury bonds were obtained from The Wall Street Journal: Coupon Maturity Rate Mo./Yr. Bid Asked Chg Ask Yld. 10 3/8 Dec. 05 133:06 133:10 3 6.27 10 5/8 Dec. 15 144:08 144:10 6 6.61 7 5/8 Dec. 25 113:22 113:24 6 6.57 4. End-of-year quotes on treasury bills were also obtained from The Wall Street Journal: Days Maturity to Mat. Bid Asked Chg. Ask Yld. Mar 30 90 5.44 5.42 0 5.59 June 29 181 5.40 5.38 +.01 5.61 Sept 19 265 5.31 5.29 0 5.55 5. Aces federal-plus-state tax rate is 40%. 6. The firms last dividend (D0) was $0.46. Here are the earnings and dividends per share over the last 5 years: Table 4 (Continued) Selected Data on Ace Repair, Inc.

Year DPS EPS 1991 $0.12 $0.60 1992 0.30 0.84 1993 0.30 1.17 1994 0.33 1.64 1995 0.46 2.30