EXCERISE PROBLEM FOR FINANCE 350EXAM

#3

GIVEN:

Jones Company has $1,000 par, 20 year, 8% annual coupon

interest bonds currently outstanding that are currently

priced at $1100 each. Joness preferred stock outstanding

is currently priced at $100 per share and pays an annual

dividend at the rate of 6%. Joness investment banker,

Solomon-Smith-Barney, indicated that any new issue of

preferred stock would incur flotation cost at the rate of 4%.

The firms common stock is currently priced at $60 per

share. Last years dividend per share was $3.00. The

company enjoys a constant annual growth rate in dividends

of 5%. Any new issue of common stock would result in a

flotation cost of $1.50 per share. Currently, the US

Treasury bill rate is 2% and the rate of return on the S&P

500 market index is expected to be 12.5% annually based

on its performance over the past 25 years. Jones Company

posts a beta of 1.6. The firms tax rate is 40%. Current

market value weights of its outstanding capital are 30% for

debt, 10% for preferred stock, and 60% for common equity.

The firm is facing the following TWO INVESTMENTS:

T Investment A Investment B

0 -10000 -10000

1 6000 4000

2 4000 4000

3 2000 6000

4 1000 2000

5 2000 1000

AND Kw USING Ke AS THE COST OF COMMON

EQUITY

FOR INVESTMENT A AND INVESTMENT B FIND:

PAYBACK

INTERNAL RATE OF RETURN

NET PRESENT VALUE

PROFITABILITY INDEX

WHICH INVESTMENT SHOULD JONES

COMPANY ACCEPT IF DECISION IS:

MUTUALLY EXCLUSIVE?

INDEPENDENT?