Question 1

Smith Enterprises
Smith Enterprises recently conducted an IPO. In this, Smith received $14 per share from the underwriter, the offering price per share was $16 and the stock price rose to $19 on the first day of trading.
-Refer to Smith Enterprises. What is the first day return on an investment in the IPO?

Accepted Answer

3/16 = .1875

Question 2

The following data have been computed for a firm: when sales are $20,000, EBIT is $5,000 and operating leverage is 2.5. Suppose sales increase to $23,000; what is the new level of EBIT?

Accepted Answer

2.5 = (change EBIT/$5000)/(3,000/20,000)
change EBIT = $1,875
new EBIT = $6,875

Question 3

What is Never-crash Airline's WACC, if their marginal tax rate equals 34%?

Accepted Answer

Ri = .045 + 1.9(.15-.045) = .2445
WACC = (.7)(.2445) + (.3)(.07)(1-.34) = .1850

Question 4

What is the Never-crash Airline's after tax cost of debt?

Accepted Answer

after tax Rd = 7%(1-.34) = 4.62%

Question 5

What is the Never-crash Airline's cost of equity?

Accepted Answer

Ri = .045 + 1.9(.15-.045) = .2445

Question 6

‪ 
-What is Bavarian Brewhouse's cost of preferred stock?

Accepted Answer

Rp = $2.50/$16.13 = .155

Question 7

‪ 
-What is Bavarian Brewhouse's cost of common equity?

Accepted Answer

Ri = .0375 + 0.85(.1755-.0375) = .1548

Question 8

‪ 
-What percentage of Bavarian Brewhouse's capital structure consists of total equity?

Accepted Answer

total equity = $5 + $45 = $50
$50/$75 = .6667

Question 9

‪ 
-Assuming no corporate taxes, what is Bavarian Brewhouse's WACC?

Accepted Answer

Rp = .155
Rd = .08
Re = .1548
WACC = (45/75).1548 + (25/75).08 + (5/75).155 = .1299

Question 10

‪ 
-What is Bavarian Brewhouse's WACC if their marginal tax rate equals 34%

Accepted Answer

Rp = .155
Rd = .08
Re = .1548
WACC = (45/75).1548 + (25/75).08(1-.34) + (5/75).155 = .1208

Question 11

Miller's Dairy Products reported sales of $1.5 million in 2002 and $2.25 million in 2003. Their EBIT in 2002 was $550,000 and in 2003 the EBIT rose to $925,000. What is the company's operating leverage?

Accepted Answer

OL = {(925-550)/550}/{(2.25-1.5)/1.5} = 1.36

Question 12

Running Shoes, Inc.
Running Shoes, Inc. has 2 million shares of stock outstanding. The stock currently sells for $12.50 per share. The firm's debt is publicly traded and was recently quoted at 90% of face value. It has a total face value of $10 million, and it is currently priced to yield 8%. The risk free rate is 2% and the market risk premium is 8%. You've estimated that the firm has a beta of 1.20. The corporate tax rate is 40%.
-Refer to Running Shoes, Inc. What is the cost of equity?

Accepted Answer

= 2% + 1.20 * 8% = 11.60%

Question 13

Running Shoes, Inc.
Running Shoes, Inc. has 2 million shares of stock outstanding. The stock currently sells for $12.50 per share. The firm's debt is publicly traded and was recently quoted at 90% of face value. It has a total face value of $10 million, and it is currently priced to yield 8%. The risk free rate is 2% and the market risk premium is 8%. You've estimated that the firm has a beta of 1.20. The corporate tax rate is 40%.
-What is the percentage of equity used by Running Shoes, Inc.?

Accepted Answer

DEBT:
FV = $10 million
MV = 90% * $10 million = $9 million
EQUITY:
MV = 2 million * $12.50 = $25 million
% equity = $25 / $34 = .7353

Question 14

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?

Accepted Answer

= .40 * $20 + .35 * $2 + .25 * (-30) = $1.20

Question 15

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?

Accepted Answer

= .25 * $25 + .50 * $6 + .25 * (-40) = -$0.75

Question 16

You are given the opportunity to play a game of high stakes gambling. The game begins by you paying an entry fee of $35,000,000 followed by a fair coin toss. If the coin toss is "heads" then you have an 80% probability of receiving a perpetuity of $10,000,000 per year and a 20% probability of receiving a perpetuity of $1,000,000 per year. Assume that the proper discount rate for the perpetual cash flow is 10%. If the coin toss is "tails"you can continue to play but you will lose $50,000,000 with certainty. Alternatively, you can make a make an opt-out payment of $10,000,000 after a "tail" to prevent you from going down such a costly path. What is the present value of playing such a game?

Accepted Answer

Value of Heads node: .8(10,000,000/.1) + .2(1,000,000/.1) = 82,000,000
Value of Tails node: -10,000,000 (since you will always opt for that instead of the 50,000,000 payment)
Present Value: -35,000,000 + .5(82,000,000) + .5(-10,000,000) = 1,000,000

Question 17

You are a professional football running back who is eligible to be a free agent. You are offered a two-year contract to play for your current team for $3,000,000. If you accept that contract, the firm retains your rights and you will not be able to play for another team at the conclusion of the contract. Otherwise, you can play for you current team for two years at a price of $2,000,000 but you have the ability to play for any team at the expiration of this agreement. What is the value of the option to pay for any team you like after two years? Assume a discount rate of 5%.

Accepted Answer

Retain rights contract: 3,000,000 * PVIFA(2,5%) = 3,000,000 * 1.8594104 = 5,578,231
Open rights contract: 2,000,000 * PVIFA(2,5%) = 2,000,000 * 1.8594104 = 3,718,821
Value of option: 5,578,231 - 3,718,821= 1,859,410

Quiz 7: Risk, Capital Budgeting and Raising Long-Term Financing

The following data have been computed for a firm: when sales are $20,000, EBIT is $5,000 and operating leverage is 2.5. Suppose sales increase to $23,000; what is the new level of EBIT?

What is Never-crash Airline's WACC, if their marginal tax rate equals 34%?

What is the Never-crash Airline's after tax cost of debt?

What is the Never-crash Airline's cost of equity?

‪ -What is Bavarian Brewhouse's cost of preferred stock?

‪ -What is Bavarian Brewhouse's cost of common equity?

‪ -What percentage of Bavarian Brewhouse's capital structure consists of total equity?

‪ -Assuming no corporate taxes, what is Bavarian Brewhouse's WACC?

‪ -What is Bavarian Brewhouse's WACC if their marginal tax rate equals 34%

Miller's Dairy Products reported sales of $1.5 million in 2002 and $2.25 million in 2003. Their EBIT in 2002 was $550,000 and in 2003 the EBIT rose to $925,000. What is the company's operating leverage?

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?