1. A firm has a $40 million capital budget limit. Five high IRR projects of about equal size are available that have initial investments totaling $30M. A sixth project has an IRR slightly lower than those of the first five, but requires a $16M investment. Several smaller projects are available with much lower IRR's. Discuss which projects should be done using capital rationing thinking.
2. When retained earnings are exhausted, the MCC breaks upward. What happens if the firm continues to raise capital after that? Does the MCC remain flat or move further upward? In either case, why?
3. Describe the difference between fixed and floating exchange rate systems.
4. Companies are sometimes able to show very rapid growth in EPS over a few years. This often gets investors interested and they bid the stock's price up. Suppose Contesco Inc. has such a record over the last three years which have been very favorable in its industry. At the same time, however, Contesco's capital has gone from 20% to 80% debt. What advice would you give to someone interested in buying Contesco stock?
5. Why may an analysis that makes even a rough estimate of the probability distribution of project NPV or IRR be infinitely more valuable to management than a point estimate? Why are scenario and especially decision tree analysis particularly valuable with regard to this issue?
6. The Basalt Corporation is considering a new venture. Management has made the following cash flow estimates for the project over the next three years under assumptions reflecting best, worst, and most likely scenarios in each year.
C1 C2 C3
Worst case $200 $300 $400
Most likely case $300 $400 $500
Best case $400 $500 $600
The expected initial outlay (C0) is $1,000, and the cost of capital is 12%. The following probability distribution for best, worst and most likely conditions is constant from year to year
Best case 25%
Most likely case 50%
Worst case 25%
Calculate the NPVs of the overall best, most likely, and worst case scenarios and the probability of each.
7. The following information is associated with a proposed new venture. The initial cost is estimated to be $75,000 and cash inflows over a six-year life are estimated to be $26,000 annually. The firm's cost of capital is 12%. However, another firm, whose sole business is in the same field as the new venture, is publicly traded and has a beta of 1.6. The average stock is currently yielding 11% and the yield on short-term treasury bills is 4%. Calculate the risk adjusted NPV for the project.
8. The following information is available concerning a firm's capital:Debt: Five thousand bonds with a face value of $1000 and an initial 20-year term were issued five years ago with a coupon rate of 8%. Today these bonds are selling for $846.30.Preferred stock: Twenty thousand shares of preferred stock paying an annual dividend of $9.50 are outstanding. The shares currently trade at $79.16.Common equity: Two hundred thousand shares of common stock are outstanding which are now selling for $22.50 per share. An annual dividend of $1.70 was just paid and is expected to grow indefinitely at 6%.Target capital structure: The firm's target capital structure is of 30% debt, 20% preferred stock, and 50% equity.The firm can issue any type of security without paying floatation costs. The combined federal and state tax rate is 40%.Calculate the firm's WACC based on itsa. Target capital structure and market returnsb. Market value based capital structure and market returns
9. Tancesco Inc. is considering acquiring Aldine Corp. which it has estimated will generate the following after tax cash flows over the next three years ($000). After that management expects a growth rate of 3% indefinitely.
1 2 3
$580 $600 $650
In addition, Tancesco thinks a merger will produce $40,000 per year in after tax synergies. Aldine has 65,000 shares of common stock outstanding. The company's beta is 1.6, the market is currently returning an average of 12% on stock investments and short term treasury bills are yielding 3%.
What should Tancesco be willing to pay per share for Aldine if management is willing to value the acquisition over an indefinitely long time horizon?
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