# Cost of equity, IRR, retained earnings break point

Question 1.

You have a chance to purchase a perpetual security that has a stated annual payment (cash flow) of $50. However, this is a unusual security in that the payment will increase at an annual rate of 5 percent per year; this increase is designated to help you keep up with inflation. The next payment to be received (your first payment, due in one year) will be $52.50. If you required rate of return is 15 percent, how much should you be willing to pay for this security?

$350, $482, $525, $556, $610?

Question 2.

Kohl COrporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preffered stock and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1000. The firm could sell, at par $100 preferred stock that pays 12 percent annual dividend, but flotation costs of 5 percent would be incurred, Kohl's beta is 1.2, the risk free rate is 10 percent, and the market risk premium is 5 percent. Kohl is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has growth rate of 8 percent. The firms policy is to use a risk premium method to find ks. The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on the new common stock total 10 percent, and the firm's marginal tax rate is 40 percent. What is Khol's retained earnings break point?

$600,000 $800,000 $1,000,000 $1,200,000 $1,400,000?

Question 3.

Kiwi Door Corporation expects to have earnings before interest and taxes during the coming year of $1,000,000 and it expects its earnings and dividends to grow indefinitely at a constant annual rate of 12.5 percent. The firm has $5,000,000 of debt oustanding bearing a coupon interest rate of 8 percent, and it has 100,000 shares of common stock outstanding. Historically, Kiwi has paid 50 percent of net earnings to common shareholders in the form of dividends. The current price of Kiwi's common stock is $40, but it would incurr a 10 percent flotation cost if it were to sell new stock. The firm's tax rate is 40 percent. What is Kiwi's cost of newly issued stock?

16.0%, 16.5%, 17.0%, 17.5%, 18.0%?

Question 4.

Coba Company is considering the purchase of a new machine to replace an existing one. The old machine was purchased 5 years ago at a cost of $20,000, and it is being depreciated on a straight line basis to zero salvage value over a 10-year life. The current market value of the old machine is $14,000. The new machine, which falls into the MACRS 5-year class, has an estimated life of 5 years, it costs $30,000, and COba plans to sell the machine at the end of the 5th year for $1,000. The new machine is expected to generate before-tax cash savings of $3,000 per year. The company's tax rate is 40 percent. What is the IRR of the proposed project?

4.1%, 2.2%, 0.0% -3.3%, 1.5%?

#### Solution Summary

Calculates price of security, cost of equity, IRR, retained earnings break point etc.