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# Preferred Stock and Cash Discounts

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Question 1: Your firm, People's Consulting Group, has been asked to consult on a potentially preferred stock offering by Brave New World. This 15% preferred stock issue would be sold at its par value of \$35 per share. Flotation costs would total \$3 per share. Calculate Brave New World's cost of preferred stock.

Question 2: Initiating a cash discount. Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The firm's current average collection period is 60 days, sales are 40,000 units, selling price is \$45 per unit, and variable cost per unit is \$36. The firm expects that the change in credit terms will result in an increase in sales to 42,000 units, that 70% of the sales will take the discount, and that the average collection period will fall to 30 days. If the firm's required rate of return on equal-risk investments is 25%, should the proposed discount be offered? (Note: Assume a 365-day year.)

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## Discount cash flows on the proposed venture at the firm's WACC

16. Capital Structure. Examine the following book-value balance sheet for University Products, Inc. What is the capital structure of the firm on the basis of market values? The preferred stock currently sells for \$15 per share and the common stock for \$20 per share. There are 1 million common shares outstanding.

17. Calculating WACC. Turn back to University Products's balance sheet from the previous prob- lem. If the preferred stock pays a dividend of \$2 per share, the beta of the common stock is .8, the market risk premium is 10%, the risk-free rate is 6%, and the firm's tax rate is 40%, what is University's weighted-average cost of capital? (LO3)

18. Project Discount Rate. University Products is evaluating a new venture into home computer systems (see Practice Problems 16 and 17). The internal rate of return on the new venture is estimated at 13.4%. WACCs of firms in the personal computer industry tend to average around 14%. Should the new project be pursued? Will University Products make the correct decision if it discounts cash flows on the proposed venture at the firm's WACC?

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