# Help with a few practice problems for test

1) Cost of Equity

The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 5 percent per year in the future. Shelby's common stock sells for $27.25 per share, its last dividend was $1.80, and it will pay a dividend of $1.89 at the end of the current year.

a. Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places.

11.94%?

b. If the firm's beta is 1.6, the risk-free rate is 5%, and the average return on the market is 14%, what will be the firm's cost of common equity using the CAPM approach? Round your answer to two decimal places.

19.4%?

c. If the firm's bonds earn a return of 10%, and analysts estimate the bond risk premium is 3 to 5 percent, what will rs be using the bond-yield-plus-risk-premium approach? (Hint: Use the midpoint of the risk premium range).

d. On the basis of the results of parts a through c, what would you estimate Shelby's cost of equity to be? Round your answer to two decimal places. MUST BE AN EXACT NUMBER

2) WACC Estimation

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $25 million in new projects. The firm's present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt.

Debt $30,000,000

Common equity 30,000,000

Total capital $60,000,000

3) New bonds will have a before tax cost of 8 percent. Common stock is currently selling at $30 a share. Stockholders' required rate of return is estimated to be 12 percent, consisting of a dividend yield of 4 percent and an expected constant growth rate of 8 percent. (The next expected dividend is $1.20, so $1.20/$30 =

4%.) The marginal corporate tax rate is 30 percent.

a. To maintain the present capital structure, how much of the new investment must be financed by common equity?

Is it 12500000?

b) b. Assume that there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity. What is the WACC? Round your answer to two decimal places.

4) Which of the following firms has the most operating leverage?

Firm A: EBIT rises by $20 when units increase by 2

Firm B: EBIT rises by $42 when units increase by 6

Firm C: EBIT rises by $7.5 when units increase by 1

Firm D: EBIT rises by $100 when units increase by 20

Firm E: EBIT rises by $25 when units increase by 5