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Corporate Finance Analysis of Projects

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1. Johnston Corporation is growing at a constant rate of 6% per year. It has both common stock and non-participating preferred stock outstanding. The cost of preferred stock (kps) is 8%. The par value of the preferred stock is $120, and the stock has a stated dividend of 10% of par. What is the market value of the preferred stock?

2. A share of common stock has just paid a dividend of $2. If the expected long-run growth rate for this stock is 15%, and if investors require a 19% rate of return, what is the price of the stock?

3. The Global Advertising Company has a marginal tax rate of 40%. The last dividend paid by Global was $.90. Global?s common stock is selling for $8.59 per share, and its expected growth rate in earnings and dividends is 5%. What is Global's cost of common stock?

4. A company has determined that its optimal capital structure consists of 40% debt and 60% equity. Given the following information, calculate the firm?s weighted average cost of capital:

kd= 6% tax rate = 40% P0=$25 Growth = 0% D0 = $2

5. The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm?s cost of capital is 14% and its tax rate is 40%, what is the project's IRR?

6. Green Grocers is deciding among two mutually exclusive projects. The two projects have the following cash flows:
Year Project A Project B
Cash Flow Cash Flow

0 -$50,000 -$30,000
1 10,000 6,000
2 15,000 12,000
3 40,000 18,000
4 20,000 12,000
The company?s cost of capital is 10% (WACC = 10%). What is the net present value (NPV) of the project with the highest internal rate of return (IRR)?

7. Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for $100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when the machine is retired at the end of Year 3. The machine will produce sales revenues of $900/year for 3 years; variable operating costs (excluding depreciation) will be 50% of sales. Operating cash inflows will begin 1 year from today (at Time 1). The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively. The company has a 40% tax rate, enough taxable income form other assets to enable it to get a tax refund from this project if the project?s income is negative, and a 10% cost of capital. Inflation is zero. What is the project?s NPV?

8. Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors? royalties are reduced, the variable cost per book will drop by $1. Assume authors? royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?

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Solution Summary

Answers seven questions on market value of the preferred stock, price of the stock, cost of common stock, weighted average cost of capital, IRR, Breakeven.

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