You are considering opening a premium lemonade stand on the corner of Main and Anywhere Street in your hometown.

You have determined that you will need $1,025 to buy equipment, a table, two chairs and other sundry items to get started. Youll also need $250 in the bank to make change with customers and purchase lemonade drink mix in a variety of flavours, including traditional lemonade, strawberry, cherry and grape flavours. Each cup of lemonade that you sell will be priced at $9.99 (after all this lemonade is made from your grandmothers secret recipe).

Sales in year 1 are estimated to be 100 cups, and you predict that sales will rise by 20% annually between in years 2 and 5. Direct materials costs are estimated to be 50% of annual sales and direct labour costs 20% of annual sales.

Fixed preparation costs will be $250 annually.

You are financing the business with a single $500 par value bond issued to your parents at a price of 135. The bond has a 10% coupon rate, and a term of 5 years. You have also issued 600 common shares to other family members at a price of $1 per share.

You recently read in the Times of Anywhere (a local newspaper) that risk free investments are offering an 8% return, and that the beta on lemonade stands is .80. The expected return in the premium lemonade market is 10%.

You have also confirmed with your accounting professor that the companys tax rate will be 10%, and the depreciation rate on lemonade stands is 15%.

Finally, your research has also determined that lemonade stands are predicted to have a perpetual growth rate of 2% after the first five years of operation.

Question 6

The cost of equity (the interest rate on the common shares) is _____%.

1. 10.00%
2. 9.60%
3. 8.60%
4. 5.71%

Question 7

True/False: The split between debt/equity (bonds/common shares) is approximately 75%/25%.

1. True
2. False

Question 8

True/False: Typically, the risk free rate is the yield-to-maturity on the Government of Canada ten-year bond.

1. True
2. False

Question 9

In class we learned how to calculate the annual depreciation tax shield on large capital investment projects. In the case of your lemonade stand, the total tax allowable depreciation is $_______.

1. $1,025
2. $750
3. $275
4. $154

Question 10

The depreciation tax-shield related to the first year of the lemonade stand would be claimed in year _____.

1. 1
2. 3
3. 4
4. 2