Fin 103 : Financial Planning Long Exam Name: __________________________________ Page # 1

Problem # 1: How would each of the following affect a firm’s cost of debt, cost of equity, and weighted
cost of capital. Indicate by a plus (+), minus(-), or a zero (0) if the factor would raise, lower, or have an
indeterminate effect on the item in question. Assume other things are held constant. (12%)
Effect on
Cost of Debt Cost of C/S WACC
1. The corporate tax rate is lowered.

2. Government’s financial policy tightens credit.

3. The firm uses more debt; that is, it increases its debt/assets
ratio.
4. The dividend payout ratio is increased.

5. The firm doubles its amount of capital it raises during the

7. The firm is an electric utility with a large investment in

Problem # 2: Lancaster Engineering Inc. (LEI) has the following capital structure, which it considers to
be optimal:
Debt ( 25% ), Preferred Stocks ( 15% ), Common Equity ( 60% )
LEI’s expected net income this year is 34,285.72; its established dividend payout ratio is 30 percent; its
marginal tax rate is 40 percent; and investors expect earnings and dividends to grow at a constant rate of 9
percent in the future. LEI paid a dividend of 3.60 per share last year, and its stock currently sells at a
price of $60 per share.
LEI can obtain new capital in the following ways:
Common New common stock has a flotation cost of 10 percent for up to 12,000 of new stock and
20 percent for all common over 12,000
Preferred New preferred stock with a dividend of 11 can be sold to the public at a price of 100
per share. However, flotation cost of 5 per share will be incurred up to 7,500 of preferred, and
flotation costs will rise to 10 per share or 10%, on all preferred over 7,500.
Debt Up to 5,000 of debt can be sold at an interest rate of 12 percent; debt in the range of 5,001 to
10,000 must carry an interest rate of 14 percent; and all debt over 10,000 will have an interest rate
of 16 percent.
LEI has the following independent investment opportunities:
Project Project Cost Annual Net Cash Project Life IRR
Flow
A 10,000 2,191.20 7 12.0 %
B 10,000 3,154.42 5 17.4
C 10,000 2,170.18 8 14.2
D 20,000 3,789.48 10 13.7
E 20,000 5,427.84 6 16.0
Fin 103 : Financial Planning Long Exam Name: __________________________________ Page # 2

Required: (20%)
1. Find the breakpoints and compute the weighted average cost of capital.
2. Construct a graph of the investments projects and choose which projects to accept.

Problem # 3: The H. Grimmer Company has compiled the data on the cost of each source of capital over
specified ranges of total new financing as shown below:
Debt Preferred Common
0 to 200,000 6% 17 % 20 %
200,000 to 500,000 5 17 22
500,000 to 750,000 7 19 22
750,000 to 1,000,000 9 19 24
Greater than 1,000,000 9 19 26
The company’s target capital structure proportions used in calculating its weighted cost of capital
are 40% debt, 20% preferred stock, 40% common stock.

Project A B C D E F G H I
Rate of 19% 15 22 14 23 13 21 17 16
Return
Initial 200,000 300,000 100,000 600,000 200,000 100,000 300,000 100,000 400,000
Investment
Calculate the weighted average cost of capital for each range of total financing and draw the
investment curve with the WACC and determine the projects to be accepted. (15%)

Problem # 4: Individual Cost of Capital (15%)

a.) The earnings, dividends, and stock price are expected to grow at 7 percent per year in the future.
Common stock sells for 23 per share, its last dividend was 2.00, and the company will pay a
dividend of 2.14 at the end of the current year. What is the cost of retained earnings?

b.) The Simmons Company expects net income of 30 Million next year. Its dividend payout ratio is
40 percent, and its debt/assets ratio is 60%. Simmons uses no preferred stock. What amount of
retained earnings does Simmons expect next year? If Simmons can borrow 12 million at an
interest rate of 11 percent, another 12 million at a rate of 12 percent, and any additional debt at a
rate of 13 percent, at what points will rising debt cost cause breaks in the WACC schedule?

c.) Starbucks company has just issued preferred stock. The stock has a 12 percent annual dividend
and a 100 par value and was sold at 97.50 per share. In addition, flotation costs of 2.50 per share
must be paid. Calculate the cost of the preferred stock. If the firm had sold the preferred stock
with a 10 percent annual dividend and a 90 net price, what would its cost have been?

Problem # 5: Calculate the cost of debt if the tax rate is 20%. Here are the given information regarding
the 2 bonds: (8%)
a.) 1,000 par, 15% semi-annual interest payments, 10 year, with market value of 950.
b.) 1M par, 20% annual interest payments, 20 year, with market value of 1,030,000.
Fin 103 : Financial Planning Long Exam Name: __________________________________ Page # 3

Problem # 6: The Lemaster Company is a new firm that wishes to determine an appropriate capital
structure. It can issue 16 percent debt. Common stock can be sold at 20 per share. In all cases, total
capitalization of the company will be 5 million, and it is expected to have a 30 percent tax rate. The
possible capital structures are:
Plan Debt Equity
1 0 % 100 %
2 30 70
3 50 50
Construct an EBIT-EPS chart for the plans. Determine the relevant indifference point. (10%)

Problem # 7: Hi Grade Regulator currently has 100,000 shares of common stock outstanding with a
market price of 60 per share. It also has 2 million in 6 percent debt. The company is considering a 3
million expansion program that it can finance with
1.) all common stock at 60 per share
2.) straight bonds at 8 percent interest
3.) half common stock at 60 per share and half 8 percent bonds
For a hypothetical EBIT level of 1 million after the expansion program, calculate the earnings per share
for each of the alternative methods of financing. Construct an EBIT-EPS graph. (10%)

Problem # 8: Karjill is the CEO of Sweethearts Company. This year, the company will be expanding by
purchasing the latest automated Matchmaking machine, who can accurately predict the future partner of
any person. The machine is worth 20 Million. With this machine, variable cost will be 20% and fixed
cost, 1 Million. The present capital structure of Sweethearts Company has 10 Million 10% bonds, 1
Million shares of common stock which has a worth of 10 Million. Apply 40% Tax rate.
The company has three financial analysis: Cliff, Ian and Edward, who surprisingly offered their
services to Karjill for free. Cliff proposed to Karjill to issue 2 Million shares of common stock worth 20
Million. Ian, however, proposed to Karjill to borrow 20 Million through long-term bonds yielding 15%
interest. Edward, not to be outdone by the first two, dated Karjill and then proposed to use 30% common
shares & 70% long-term bonds. With these proposals, Karjill is really at a lost. Help Karjill make her
decision that would maximize stockholders’ earnings. (10%)
a.) Compute the EBIT-EPS indifference point for the proposals.
b.) Which proposal is the best if the forecasted sales volume for the year will be--
1.) 3.5 Million
2.) 5 Million
3.) 10 Million