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After reading this chapter, it isn't surprising that you're becoming an investment wizard. With you newfound expertise, you purchase 100 shares of KSU Corporation for $37 per share. OVer the next 12 months assume the price goes up to $45 per share and you receive a qualified dividend of $0.50 per share. What would be your total return on your KSU Corporation investment? Assuming you continue to hold the stock, calculate the after-tax return. How is your realzed after-tax return different if you sell the stock? In both cases, aussme you are in the 25 percent federal marginal tax bracket and 15 percent long-term capital gains and qualified dividends tax bracket and there is no state income tax on investment income.

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Jamar Ferry
Jamar FerryLv2
28 Sep 2019
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After reading this​ chapter, it​ isn't surprising that​ you're becoming an investment wizard. With your newfound​ expertise, you purchase 100 shares of KSU Corporation for ​$28.42 per share. Assume the price goes up to $ 34.05 per share over the next 12 months and you receive a qualified dividend of ​$0.55 per share. What would be your total return on your KSU Corporation​ investment? Assuming you continue to hold the​ stock, calculate your​ after-tax return. How is your realized​ after-tax return different if you sell the​ stock? In both cases assume you are in the 25 percent federal marginal tax bracket and 15 percent​ long-term capital gains and qualified dividends tax bracket and there is no state income tax on investment income

Problem 1

Calculate all MCC break points for the following information:

Total assets = $1,500,000

Total debt = $600,000

Total equity = $900,000

kd is 10% up to $500,000 and is 11% after $500,000

ks is 13% up to $100,000 and is 14% after $100,000

Problem 2

Calculate the AT kd, ks, kn for the following information:

Loan rates for this firm = 9%

Growth rate of dividends = 4%

Tax rate = 30%

Common Dividends at t1 = $ 4.00

Price of Common Stock = $35.00

Flotation costs = 6%

problem3

Your firm is in the 30% tax bracket with a before-tax required rate of return on its equity of 13% and on its debt of 10%. If the firm uses 60% equity and 40% debt financing, calculate its after-tax WACC.

problem 4

Babe's Dog Obedience School, Inc., wants to maintain its current capital structure of 50 percent common equity, 10 percent preferred stock, and 40 percent debt. Its cost of common equity is 13 percent, and the cost of preferred stock is 12 percent. The bank's effective annual interest rate is 11 percent for amounts borrowed that are less than or equal to $1 million and 13 percent for amounts between $1 million and $2 million. If more than $2 million is borrowed, the effective annual interest rate charged is 15 percent. Babe's tax rate is 40 percent. The firm expects to realize $2,750,000 in net income this year after preferred dividends have been paid. The current price per share of Babe's common stock is $44.23, the expected dividend per share is $4.20, the expected growth rate is 4 percent. If Babe needs to issue new common stock, the flotation cost is 5 percent of share price.

Here are the investment opportunity options that Babe is considering:

Project A requires an initial investment of $900,000. The expected rate of return for Project A is 11.75%.

Project B requires an initial investment of $2,100,000. The expected rate of return for Project B is 11.50%.

Project C requires an initial investment of $2,100,000. The expected rate of return for Project C is 11.40%.

Project D requires an initial investment of $9,000,000. The expected rate of return for Project D is 11.00%.

**Express all of the percentage answers to two (2) decimal places.**

a. Calculate the first debt break point.

b. Calculate the second debt break point.

c. Calculate the equity break point.

d. Calculate the highest MCC for Project A only.

e. Calculate the highest MCC for Projects A and B.

f. Calculate the highest MCC for Projects A, B, and C,

g. Calculate the highest MCC for Projects A, B, C, and D.

h. Based on your analysis, which project(s) would you recommend that Babe undertake?

I have created a graph to help you "see " this problem and more fully understand the analysis that you are doing (see below). I have covered the exact numbers for the respective MCCs, but the graph should tell you if your calculations using the formulas are correct. Remember to express all of your MCCs in percentages to two (2) decimal places. That is how I will know that you know how to use the formulas.

Assume all bonds in these problems are semi-annual bonds with $1000 par value 1. Calculate the yield to maturity for the following corporate bond
Company(Ticker) Coupon Maturity Last Price Merck (MRK) 4.375 April 15, 2031 98.211
2. US Treasury Strips are zero-coupon securities. Suppose you wish to purchase a US Treasury Strip that matures exactly 10 years from now. If the yield on 10-year US Treasury securities is currently 2.40%, what is the correct price quote for this bond? (Use semi- annual compounding).
3. A corporate bond has a coupon rate of 5.5% and a yield to maturity of 4.905%. You buy the bond when it is quoted at 102.10 percent of par. It has been 75 days since the last coupon payment was made. How much must you pay, per bond?
4. RJ Wagner Insurance Co. preferred stock pays a cash dividend of $2.00 per share, per year. The current price of this stock is $51.95. What is the yield on this preferred? Suppose an individual is considering investing in this preferred stock, versus a AAA-rated municipal bond that has a yield to maturity of 2.195%. Which has the higher after tax yield if the investor pays 45% of her income in state and federal income taxes, and the municipal bond interest is tax exempt?
5. Heavy Metal Corporation is expected to generate Free Cash Flow of $75 million in the current year. The free cash flow is expected to grow at a 3% rate forever. Heavy Metal has 20 million shares outstanding, $400 million in debt and no excess cash. The tax rate is 40%, the required return on equity is 12%, and the WACC (cost of capital) is 9%. Compute the Enterprise Value of Heavy Metal and the value of the equity per share.
6a) IBM Corp. earned $12.25 in EPS last year. IBM has recently adopted a long-term target to pay out 50% of all future earnings as dividends. IBM’s dividends and earnings are expected to grow at a constant rate of 3% in the future. You require a 9% rate of return on stock investments of similar risk. What is your estimate of the market value of IBM stock?
6b). Based on the information provided what is the implied return on new investment (ROE*) for IBM.
7. Bunge Corp. earned $9.75 per share and paid $3.25 in dividends in the year just ended. Bunge’s (trailing) P/E ratio is 15.0. If Bunge dividends are expected to grow at a 5% rate forever, what is the expected rate of return on Bunge stock?
8. Monsanto, Corp paid dividends of $8.80 last year. You develop the following forecast for Monsanto’s future dividends: growth of 20% for 2 years, growth of 10% in years 3, 4 and 5, and growth of 5% per year, forever, after year 5. If investors required return on Monsanto stock is 15%, what is the estimated market value according to the multi-stage dividend discount model?

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