Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

CHAPTER 1
Questions:
1. What are the three types of financial management decisions? For each type of decision,
give an example of a business transaction that would be relevant?
2. What is the primary disadvantage of the corporate form of organization? Name at least
two advantages of corporate organization?
3. What goal should always motivate the action of a firm’s financial manager?
4. Who owns a corporate? Describe the process whereby the owners control the firm’s
management. What is the main reason that an agency relationship exists in the corporate
form of organization? In this context, what kinds of problems can arise?
5. Distinguish, show how to calculate and the meaning of EBITDA, EBIT, EBT, EAT,
EPS, ROI, ROS, ROA, ROE
6. What is a tax shield? Which expenses are used as tax shields for the firms?
Exercises
1.1. ABC, Inc., considers investing in productions line with following information (Unit:
million dollars)
Revenue: 1500
Operating cost (Excluding depreciation cost): 800
Project life: 5 years.
The fixed asset has a historical cost of $1200 million, is amortized over a 5-year period
according to scenarios (i) Straight-line depreciation in 5 years; (ii) Straight-line
depreciation in 4 years; (iii) Reducing balance method (DDB) in 5 years. Assume a
corporate tax rate of 20%.
Calculate the corporate tax in each scenario. In your opinion, which form of depreciation
should ABC Inc. choose?
1.2. ABC Inc. has a financial plan in 200X as follows:
- Earning after tax: $500 million
- Depreciation cost: $400 million
- Average total asset is $3200 million, of which 35% is financed equity.
- The corporate tax rate of 20%
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

- The interest of debt (before tax): 8 percent per year.

a. Calculate EBITDA, EBIT, EBT, EAT, ROE
b. Calculate the interest tax shield and after-tax cost of debt?
c. In the case of equity financing 50% of total assets, how does EBIT change?

CHAPTER 2
Exercises
2.1. Calculating EAR: Find the EAR in each of the following cases:
Stated Rate (APR) Number of times Effective rate (EAR)
compounded
9% Quarterly
16 Monthly
12 Daily
11 Semiannually
2.2. Calculating APR: Find the APR, or state rate in each of the following cases
Stated Rate (APR) Number of times Effective rate (EAR)
compounded
Semiannually 11.1%
Monthly 19.6
Weekly 10.5
Quarterly 8.4
2.3. Calculating EAR: First National Bank charges 13.1 percent compounded monthly on
its business loans. First United Bank charges 13.4 percent compounded semiannually. As
a potential borrower, which bank would you go to for a new loan?
2.4. Calculating APR: Elliott Credit Corp. wants to earn an effective annual return on its
consumer loans of 17.1 percent per year. The bank uses daily compounding on its loans.
What interest rate is the bank required by law to report to potential borrowers? Explain
why this rate is misleading to an uninformed borrower
2.5. EAR versus APR. EAR versus APR Big Dom’s Pawn Shop charges an interest rate of
27 percent per month on loans to its customers. Like all lenders, Big Dom must report an
APR to consumers. What rate should the shop report? What is the effective annual rate?
2.6. Calculating EAR: You are looking at an investment that has an effective annual rate
of 11.6 percent. What is the effective semiannual return? The effective quarterly return?
The effective monthly return?
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

2.7. Calculating Future value: For each of the following, compute the future value
Present value Years Interest rate Future value
$ 2,382 11 13%
7,513 7 9
74,381 14 12
192,050 16 6
2.8. Calculating Present value: For each of the following, compute the present value
Present value Years Interest rate Future value
13 9% $ 16,832
4 7 48,318
29 13 886,073
40 21 550,164
2.9. Present and future values of a cash flow stream: An investment will pay $150 at the
end of each of the next 3 years; $250 at the end of Year 4, $ 300 at the end of year 5, and
$500 at the end of Year 6. If other investment of equal risk earn 11% annually, what is its
present value? Its future value at the end of Year 6. In the case the cash flows pay at the
beginning of each year, what is its present value and its future value at the end of Year 6?
2.10. Future value of an annuity. Find the future values of these ordinary annuities.
Compounding occurs once a year
a. $500 per year for 8 years at 14%
b. $250 per year for 4 years at 7%
c. $700 per year for 4 years at 0%
d. Rework parts a, b, c assuming they are annuities due
2.11. Present value of an annuity: The present of these ordinary annuities. Discounting
occurs once a year
a. $600 per year for 12 years at 8%
b. $300 per year for 6 years at 4%
c. $500 per year for 6 years at 0%
d. Rework parts a,b and c assuming they are annuities due.
2.12. Future value of an annuity: Your client is 26 years old. She wants to begin saving for
retirement, with the first payment to come one year from now. She can save $8,000 per
year, and you advise her to invest it in the stock market, which you expect to provide an
average return of 10% in the future
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

a. If she follows your advice, how much money will she have at 65?
b. How much will she have at 70?
s. She expects to live for 20 years if she retires at 65 and for 15 years if she retires at 70. If
her investments continue to earn the same rate, how much will she be able to withdraw at
the end of each year after retirement at each retirement age?
2.13. Evaluating lump sums and annuities: Kristina just won the lottery, and she must
choose among three award options. She can select to receive a lump sum today of $62
million, to receive 10 end-of-year payments of $9.5 million, or to receive 30 end-of-year
payments of $5.6 million.
a. If she thinks she can earn 7% annually, which should she choose?
b. If she expects to earn 8% annually, which is the best choice?
c. If she expects to earn 9% annually, which option would you recommend?
d. Explain how interest rates influence her choice.
2.14 Future value of an annuity: Find the future values of the following ordinary:
a. FV of $400 paid each 6 months for 5 years at a nominal rate of 12% compounded
semiannually
b. FV of $200 paid each 3 months for 5 years at a nominal rate of 12% compounded
quarterly
c. These annuities receive the same amount of cash during the 5-year period and earn
interest at the same nominal rate, yet the annuity in part b ends up larger than the one in
part a. Why does this occur?
2.14. PV of uneven cash flow: You want to buy a house within 3 years, and you are
currently saving for the down payment. You plan to save $9,000 at the end of the first year,
and you anticipate that your annual savings will increase by 5% annually thereafter. Your
expected annual return is 8%. How much will you have for a down payment at the end of
Year 3?
2.15. Growing annuity: You have just won the lottery and will receive $1,500,000 in one
year. You will receive payments for 30 years, and the payments will increase by 2.7 percent
per year. If the appropriate discount rate is 6.8 percent, what is the present value of your
winnings?
2.16. Growing annuity: Your job pays you only once a year for all the work you did over
the previous 12 months. Today, December 31, you just received your salary of $55,000
and you plan to spend all of it. However, you want to start saving for retirement beginning
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

next year. You have decided that one year from today you will begin depositing 9 percent
of your annual salary in an account that will earn 10 percent per year. Your salary will
increase at 3 percent per year throughout your career. How much money will you have on
the date of your retirement 40 years from today
2.17. Calculating Interest rate: Solve for the unknown interest rate in each of the following:
Present value Years Interest rate Future value
$181 5 $ 317
335 17 1,080
48,000 13 185,382
40,353 30 531,618
2.18. Calculating the number of periods: Solve for the unknown number of years in each
of the following
Present value Years Interest rate Future value
$560 7% $ 1,389
810 8 1,821
18,400 9 289,715
21,500 11 430,258
2.19. Calculating the number of payments: You’re prepared to make monthly payments of
$175, beginning at the end of this month, into an account that pays 7 percent interest
compounded monthly. How many payments will you have made when your account
balance reaches $15,000?
2.20. a. Amortization with equal payment: Prepare an amortization schedule for a five-
-year loan of $71,500. The interest rate is 7 percent per year, and the loan calls for equal
annual payments. How much interest is paid in the third year? How much total interest is
paid over the life of the loan?
b. Amortization with Equal Principal Payments: Rework Problem 55 assuming that the
loan agreement calls for a principal reduction of $14,300 every year instead of equal annual
payments.
2.21. AMORTIZATION SCHEDULE WITH A BALLOON PAYMENT You want to buy
a house that costs $140,000. You have $14,000 for a down payment, but your credit is such
that mortgage companies will not lend you the required $126,000. However, the realtor
persuades the seller to take a $126,000 mortgage (called a seller take-back mortgage) at a
rate of 5%, provided the loan is paid off in full in 3 years. You expect to inherit $140,000
in 3 years, but right now all you have is $14,000, and you can afford to make payments of
no more than $22,000 per year given your salary. (The loan would call for monthly
payments, but assume end-of-year annual payments to simplify things.)
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

a. If the loan was amortized over 3 years, how large would each annual payment be? Could
you afford those payments?
b. If the loan was amortized over 30 years, what would each payment be? Could you afford
those payments?
c. To satisfy the seller, the 30-year mortgage loan would be written as a balloon note, which
means that at the end of the third year, you would have to make the regular payment plus
the remaining balance on the loan. What would the loan balance be at the end of Year 3,
and what would the balloon payment be?
2.22. Bond valuation: The Pennington Corporation issued a new series of bonds on January
1, 1994. The bonds were sold at par ($1,000), had a 12% coupon, and mature in 30 years,
on December 31, 2023. Coupon payments are made semiannually (on June 30 and
December 31).
a. What was the YTM on January 1, 1994?
b. What was the price of the bonds on January 1, 1999, 5 years later, assuming that interest
rates had fallen to 10%?
c. Find the current yield, capital gains yield, and total return on January 1, 1999, given the
price as determined in part b.
d. On July 1, 2017, 6½ years before maturity, Pennington’s bonds sold for $916.42. What
were the YTM, the current yield, the capital gains yield, and the total return at that time?
2.23. Bond valuation. Madsen Motors’s bonds have 23 years remaining to maturity.
Interest is paid annually, they have a $1,000 par value, the coupon interest rate is 9%, and
the yield to maturity is 11%. What is the bond’s current market price?
2.24. YIELD TO MATURITY AND FUTURE PRICE A bond has a $1,000 par value, 12
years to maturity, and an 8% annual coupon and sells for $980.
a. What is its yield to maturity (YTM)?
b. Assume that the yield to maturity remains constant for the next three years. What will
the price be 3 years from today?
2.25. Yield to call: It is now January 1, 2018, and you are considering the purchase of an
outstanding bond that was issued on January 1, 2016. It has an 8% annual coupon and had
a 30-year original maturity. (It matures on December 31, 2045.) There is 5 years of call
protection (until December 31, 2020), after which time it can be called at 108—that is, at
108% of par, or $1,080. Interest rates have declined since it was issued, and it is now selling
at 119.12% of par, or $1,191.20.
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

a. What is the yield to maturity? What is the yield to call?

b. If you bought this bond, which return would you actually earn? Explain your reasoning.
2.26. YIELD TO MATURITY AND YIELD TO CALL. Kempton Enterprises has bonds
outstanding with a $1,000 face value and 10 years left until maturity. They have an 11%
annual coupon payment, and their current price is $1,185. The bonds may be called in 5
years at 109% of face value (Call price = $1,090).
a. What is the yield to maturity?
b. What is the yield to call if they are called in 5 years?
c. Which yield might investors expect to earn on these bonds? Why?
d. The bond’s indenture indicates that the call provision gives the firm the right to call the
bonds at the end of each year beginning in Year 5. In Year 5, the bonds may be called at
109% of face value, but in each of the next 4 years, the call percentage will decline by 1%.
Thus, in Year 6, they may be called at 108% of face value; in Year 7, they may be called
at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain
at their current level, when is the latest that investors might expect the firm to call the
bonds?
2.27. Stock valuation. Burnett Corp. pays a constant $8.25 dividend on its stock. The
company will maintain this dividend for the next 13 years and will then cease paying
dividends forever. If the required return on this stock is 11.2 percent, what is the current
share price?
2.28. Valuing perferred Stock: Bedekar, Inc., has an issue of preferred stock outstanding
that pays a $3.40 dividend every year in perpetuity. If this issue currently sells for $91 per
share, what is the required return?
2.29. Constant growth stock valuation. Fletcher Company’s current stock price is $36.00,
its last dividend was $2.40, and its required rate of return is 12%. If dividends are expected
to grow at a constant rate, g, in the future, and if re is expected to remain at 12%, what is
Fletcher’s expected stock price 5 years from now?
2.30. Nonconstant growth stock. Snyder Computers Inc. is experiencing rapid growth.
Earnings and dividends are expected to grow at a rate of 15% during the next
2 years, at 13% the following year, and at a constant rate of 6% during Year 4 and
thereafter. Its last dividend was $1.15, and its required rate of return is 12%.
a. Calculate the value of the stock today.
b. Calculate P1; P2
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

c. Calculate the dividend and capital gains yields for Years 1, 2, and 3
2.31. Prefferred stock returns. vondale Aeronautics has perpetual preferred stock
outstanding with a par value of $100. The stock pays a quarterly dividend of $1.00 and its
current price is $45.
a. What is its nominal annual rate of return?
b. What is its effective annual rate of return?
2.32. Constant growth valuation
a. Holtzman Clothiers’s stock currently sells for $38.00 a share. It just paid a dividend of
$2.00 a share (i.e., D0 = $2.00). The dividend is expected to grow at a constant rate of 5%
a year. What stock price is expected 1 year from now? What is the required rate of return?
b. Tresnan Brothers is expected to pay a $1.80 per share dividend at the end of the year
(i.e., D1 = $1.80). The dividend is expected to grow at a constant rate of 4% a year. The
required rate of return on the stock, rs, is 10%. What is the stock’s current value per share
2.33. NONCONSTANT GROWTH STOCK VALUATION. Taussig Technologies
Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same
growth rate is expected to last for another 2 years, then decline to gn 5 6%.
a. If D0= $1.60 and re 5 10%, what is TTC’s stock worth today? What are its expected
dividend, and capital gains yields at this time, that is, during Year 1?
b. Now assume that TTC’s period of supernormal growth is to last for 5 years rather than
2 years. How would this affect the price, dividend yield, and capital gains yield? Answer
in words only.
c. What will TTC’s dividend and capital gains yields be once its period of supernormal
growth ends? (Hint: These values will be the same regardless of whether you examine the
case of 2 or 5 years of supernormal growth; the calculations are very easy.)
d. Explain why investors are interested in the changing relationship between dividend and
capital gains yields over time.
2.34. CONSTANT GROWTH. Your broker offers to sell you some shares of Bahnsen &
Co. common stock that paid a dividend of $2.00 yesterday. Bahnsen’s dividend is expected
to grow at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3
years and then sell it. The appropriate discount rate is 12%.
a. Find the expected dividend for each of the next 3 years; that is, calculate D1, D2, and D3
Note that D0=$2.00.
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

b. Given that the first dividend payment will occur 1 year from now, find the present value
of the dividend stream; that is, calculate the PVs of D1, D2, and D3, and then sum these
PVs.
c. You expect the price of the stock 3 years from now to be $34.73; that is, you expect P 3
to equal $34.73. Discounted at a 12% rate, what is the present value of this expected future
stock price? In other words, calculate the PV of $34.73.
d. If you plan to buy the stock, hold it for 3 years, and then sell it for $34.73, what is the
most you should pay for it today?
e. Calculate the present value of this stock. Assume that g 5 5% and that it is constant.
f. Is the value of this stock dependent upon how long you plan to hold it? In other words,
if your planned holding period was 2 years or 5 years rather than 3 years, would this affect
the value of the stock today, P0? Explain.
2.35. NPV. Your division is considering two projects with the following cash flows (in
millions):
0 1 2 3
Project A -$25 $5 $10 $17
Project B -$20 $10 $9 $6
a. What are the projects’ NPVs assuming the WACC is 5%? 10%? 15%?
b. What are the projects’ IRRs at each of these WACCs?
c. If the WACC was 5% and A and B were mutually exclusive, which project would you
choose? What if the WACC was 10%? 15%? (Hint: The crossover rate is 7.81%.)
2.36. CAPITAL BUDGETING CRITERIA. A firm with a 14% WACC is evaluating two
projects for this year’s capital budget. After-tax cash flows, including depreciation, are as
follows:
0 1 2 3 4 5
Project M -$30,000 $10,000 $10,000 $10,000 $10,000 $10,000
Project N -$90,000 $28,000 $28,000 $28,000 $28,000 $28,000
a. Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.
b. Assuming the projects are independent, which one(s) would you recommend?
c. If the projects are mutually exclusive, which would you recommend?
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict
between NPV and IRR?
2.37. Capital budgeting criteria. A company has an 11% WACC and is considering two
mutually exclusive investments (that cannot be repeated) with the following cash flows:
0 1 2 3 4 5
Project M -$30,000 $10,000 $10,000 $10,000 $10,000 $10,000
Project N -$90,000 $28,000 $28,000 $28,000 $28,000 $28,000
Calculate NPV, IRR, MIRR, payback, and discounted payback for each project? Which
project would you recommend?

CHAPTER 3
Questions
3.1. What are the two basic types of risk? What is the distinction between the two types of
risks?
3.2. What is the fundamental relationship between risk and return in well-functioning
markets?
3.3. What is the capital asset pricing model (CAPM)? What does it tell us about the required
return on a risky investment?
Exercises
3.1. Calculating returns. Suppose a stock had an initial price of $65 per share, paid a
dividend of $1.45 per share during the year, and had an ending share price of $71. Compute
the percentage total return? What was the dividend yield? The capital gains yield? In the
case assuming the endind share os $58, calculate the dividend yield? The capital loss yield
and the percentage total return?
3.2. Calculating returns. Suppose you bought a bond with an annual coupon of 7 percent
one year ago for $1,010. The bond sells for $985 today
a. Assuming a $1,000 face value, what was your total dollar return on this investment over
the past year?
b. What was your total nominal rate of return on this investment over the past year?
c. If the inflation rate last year was 3 percent, what was your total real rate of return on this
investment?
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

3.3. Calculating returns and risk. Using the following returns, calculate the arithmetic
average returns, the variances, and the standard deviations for X and Y
Return
Year X Y
1 12% 25%
2 28 34
3 9 13
4 -7 -27
5 10 14
3.4. Calculating returns and risk. You’ve observed the following returns on Cash-n-Burn
Computer’s stock over the past five year: 8%; -15%; 19%; 31% and 21%
a. What was the arithmetic average return on the company’s stock over this five year
period?
b. What was the variance of the company’s returns over this period? The standard
deviation?
3.5. Calculating returns and risks. You find a certain stock that had returns of 9%, -16%;
18%; 14% for four of the last five year. If the average return of the stock over this periof
was 10.3%, what was the stock’s return for the missing year? What is the standard deviation
of the stock return?
3.6. Determining portfolio weights. What are the portfolio weights for a portfolio that has
115 share of stock A sell for $43 per share and 180 share of stock B that sell for $ 19 per
share?
3.7. Portfolio expected return. You own a portfolio that has $3,480 invested in stock A and
$7,430 invested in Stock B. If the expected returns on these stocks are 8% and 11%,
respectively, what is the expected return on the portfolio?
3.8. Portfolio expected return. You own a portfolio that is invested 35% in stock X, 20%
in stock Y, and 45% in stock Z. The expected returns on these three stocks are 9%, 15%
and 12%, respectively. What is the expected return, variance and standard deviation on the
portfolio?
3.9. Calculating expected return. Based on the following information, calculate the
expected return, variance, and standard deviation
State of economy Probability of state Portfolio return if
of economy state occurs
Recession .10 -0.15
Normal .60 0.09
Boom .30 0.23
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

3.10. Calculating returns and standard deviaitons. Based on the following information,
calculate:
a. Expected return and standard deviation for stock A and stock B
b. Expected return and standard deviation for portfolio that is invested 40% in stock A
and 60% in stock B.

State of economy Probability of Rate of return if state occurs

state of economy Stock A Stock B
Recession .10 4% -17%
Normal .60 9% 12%
Boom .30 17% 27%
3.11. Calculating portfilio betas. You own a stock portfolio invested 20% in stock Q, 30%
in stock R, 35% in stock S, and 15% in stock T. The betas for these four stocks are 0.79;
1.23; 1.13 and 1.36, respectively. What is the portfolio beta?
3.12. Calculating portfolio betas. You own a portfolio equally invested in a riskfree asset
and two stocks. If one of the stocks has a beta of 1.17 and the total portfolio is equally as
risky as the market, what must the beta be for the other stock in your portfolio?
3.13. Using CAPM
a. A stock has a beta of 1.15, the expected return on the market is 10.3 percent, and the
risk-free rate is 3.1 percent. What must the expected return on this stock be?
b. A stock has an expected return of 10.2 percent, the risk-free rate is 3.9 percent, and the
market risk premium is 7.2 percent. What must the beta of this stock be?
c. A stock has an expected return of 10.45 percent, its beta is .93, and the risk-free rate is
3.6 percent. What must the expected return on the market be?
d. A stock has an expected return of 11.85 percent, its beta is 1.24, and the expected return
on the market is 10.2 percent. What must the risk-free rate be?
3.14. Portfolio returns and deviations. Consider the following information about three stock
State of economy Probability of Rate of return if state occurs
state of Stock A Stock B Stock C
economy
Recession .15 .00 -.21 -.45
Normal .60 .17 .11 .09
Boom .25 .21 .33 .55
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the
portfolio expected return? The variance? The standard deviation?
b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the
portfolio?
c. If the expected inflation rate is 3.30 percent, what are the approximate and exact expected
real returns on the portfolio? What are the approximate and exact expected real risk
premiums on the portfolio?

CHAPTER 4.

4.1. Calculating cost of equity. The Drogon Co. just issued a dividend of $2.80 per share
on its common stock. The company is expected to maintain a constant 4.5 percent growth
rate in its dividends indefinitely. If the stock sells for $58 a share, what is the company’s
cost of equity?
4.2. Calculating cost of equity. The Rhaegel Corporation’s common stock has a beta of
1.07. If the risk-free rate is 3.5 percent and the expected return on the market is 10 percent,
what is the company’s cost of equity capital?
4.3. Calculating cost of equity. Stock in Daenerys Industries has a beta of 1.05. The market
risk premium is 7 percent, and T-bills are currently yielding 3.4 percent. The company’s
most recent dividend was $2.35 per share, and dividends are expected to grow at an annual
rate of 4.1 percent indefinitely. If the stock sells for $43 per share, what is your best
estimate of the company’s cost of equity?
4. Estimating the DCF (Discounted cash flow) growth rate. Suppose Stark, Ltd., just issued
a dividend of $2.51 per share on its common stock. The company paid dividends of $2.01,
$2.17, $2.25, and $2.36 per share in the last four years. If the stock currently sells for $43,
what is your best estimate of the company’s cost of equity capital using the arithmetic
average growth rate in dividends? What if you use the geometric average growth rate?
4.5. Calculating cost of preferred stock. Holdup Bank has an issue of preferred stock with
a stated dividend of $4.25 that just sold for $93 per share. What is the bank’s cost of
preferred stock?
4.6. Calculating cost of debt. Viserion, Inc., is trying to determine its cost of debt. The firm
has a debt issue outstanding with 23 years to maturity that is quoted at 103 percent of face
value. The issue makes semiannual payments and has an embedded cost of 6 percent
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

annually. What is the company’s pretax cost of debt? If the tax rate is 21 percent, what is
the aftertax cost of debt?
4.7. Calculating cost of debt. Jiminy’s Cricket Farm issued a 30-year, 6 percent semiannual
bond three years ago. The bond currently sells for 93 percent of its face value. The
company’s tax rate is 22 percent.
a. What is the pretax cost of debt?
b. What is the aftertax cost of debt?
c. Which is more relevant, the pretax or the aftertax cost of debt? Why?
4.8. Calculating WACC. Targaryen Corporation has a target capital structure of 70 percent
common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 10
percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 6 percent.
The relevant tax rate is 23 percent.
a. What is the company’s WACC?
b. The company president has approached you about the company’s capital structure. He
wants to know why the company doesn’t use more preferred stock financing because it
costs less than debt. What would you tell the president?
4.9. Calculating WACC. Lannister Manufacturing has a target debt-equity ratio of .55. Its
cost of equity is 11 percent, and its cost of debt is 6 percent. If the tax rate is 21 percent,
what is the company’s WACC?
4.10. Finding the target capital structure. Fama’s Llamas has a weighted average cost of
capital of 7.9 percent. The company’s cost of equity is 11 percent, and its pretax cost of
debt is 5.8 percent. The tax rate is 25 percent. What is the company’s target debt-equity
ratio?
4.11. WACC with the book value and market value. Dinklage Corp. has 7 million shares
of common stock outstanding. The current share price is $68, and the book value per share
is $8. The company also has two bond issues outstanding. The first bond issue has a face
value of $70 million, a coupon rate of 6 percent, and sells for 97 percent of par. The second
issue has a face value of $40 million, a coupon rate of 6.5 percent, and sells for 108 percent
of par. The first issue matures in 21 years, the second in 6 years. Both bonds make
semiannual coupon payments.
a. What are the company’s capital structure weights on a book value basis?
b. What are the company’s capital structure weights on a market value basis?
c. Which are more relevant, the book or market value weights? Why?
Nguyen Thi Nhu Quynh, Faculity of Finance, HUB

d. suppose the most recent dividend was $3.25 and the dividend growth rate is 5 percent.
Assume that the overall cost of debt is the weighted average of that implied by the two
outstanding debt issues. Both bonds make semiannual payments. The tax rate is 21 percent.
What is the company’s WACC?
4.12. Calculating the WACC. Given the following information for Watson Power Co., find
the WACC. Assume the company’s tax rate is 21 percent.
Debt: 15,000 bonds with a 5.8 percent coupon outstanding, $1,000 par value, 25 years to
maturity, selling for 108 percent of par; the bonds make semiannual payments.
Common stock: 575,000 shares outstanding, selling for $64 per share; the beta is 1.09.
Preferred stock: 35,000 shares of 2.8 percent preferred stock outstanding, currently selling
for $65 per share.
Market: 7 percent market risk premium and 3.2 percent risk-free rate.
4.13. Finding WACC. Titan Mining Corporation has 7.5 million shares of common stock
outstanding, 250,000 shares of 4.2 percent preferred stock outstanding, and 140,000 bonds
with a semiannual coupon of 5.1 percent outstanding, par value $1,000 each. The common
stock currently sells for $51 per share and has a beta of 1.15, the preferred stock currently
sells for $103 per share, and the bonds have 15 years to maturity and sell for 107 percent
of par. The market risk premium is 7.5 percent, T-bills are yielding 2.4 percent, and the
company’s tax rate is 22 percent.
a. What is the firm’s market value capital structure?
b. If the company is evaluating a new investment project that has the same risk as the firm’s
typical project, what rate should the firm use to discount the project’s cash flows?