1.

Browning's Motor Works is reviewing its current accounts to determine how a proposed
project might affect the account balances. The firm estimates the project will initially
require $57,000 in additional current assets and $32,000 in additional current liabilities.
The firm also estimates the project will require an additional $7,000 a year in current
assets for each one of the four years of the project. How much net working capital will
the firm recoup at the end of the project assuming that all net working capital can be
recaptured?
57000-32000+7000*4 = $53000
2. Lakeside Winery is considering expanding its wine-making operations. The expansion
will require new equipment costing $649,000 that would be depreciated on a straight-line
basis to a zero balance over the 4-year life of the project. The estimated salvage value is
$187,000. The project requires $38,000 initially for net working capital, all of which will
be recouped at the end of the project. The projected operating cash flow is $198,500 a
year. What is the net present value of this project if the relevant discount rate is 14
percent and the tax rate is 35 percent?
Cashflows
Initial investment
Working captial

0
64900
0
38000

Operating
cshflow

19850
0
16225
0

19850
0
16225
0

less Depreciation
Earnings before
taxes
less taxes
Earnings after
taxes

162250

19850
0
16225
0

36250
12688

36250
12688

36250
12688

36250
12688

23563

Net cash flows

add working
capital
add salvage
value

185813

23563
18581
3

23563
18581
3

23563
18581
3

198500

38000
12155
0

187000*65
Net cash flows
PVIF

68700
0
1

185813
0.8771
93

18581
3
0.769
47

18581
3
0.674
97

34536
3
0.592
08

68700
0

PV

162993

14297
7

12541
8

20448
2

-51129
NPV

3. A project has an initial requirement of $261,000 for fixed assets and $27,000 for net
working capital. The fixed assets will be depreciated to a zero book value over the 4-year
life of the project and have an estimated salvage value of $78,000. All of the net working
capital will be recouped at the end of the project. The annual operating cash flow is
$96,200 and the discount rate is 13 percent. What is the project's net present value if the
tax rate is 35 percent?
Cashflows
Initial investment
Working captial

0
26100
0
27000

Operating
cshflow
less Depreciation
Earnings before
taxes
less taxes
Earnings after
taxes
Net cash flows
add working
capital
add salvage
value
78000*65
Net cash flows
PVIF
PV

96200
65250

96200
65250

96200
65250

96200
65250

30950
10833

30950
10833

30950
10833

30950
10833

20118
85368

20118
85368

20118
85368

20118
85368
27000

50700
28800
0
1
28800
0

85368
0.88495
58

85368
0.783
15

85368
0.693
05

16306
8
0.6133
19

75546

66855

59164

10001
2

13578
NPV

4. A firm has a return on equity of 12.4 percent according to the dividend growth model
and a return of 18.7 percent according to the capital asset pricing model. The market rate
of return is 13.5 percent. What rate should the firm use as the cost of equity when
computing the firm's WACC?
Company should use 18.7%
5. Judy's Boutique just paid an annual dividend of $1.65 on its common stock. The firm
increases its dividend by 2.5 percent annually. What is the rate of return on this stock if
the current stock price is $38.20 a share?
1.65*1.025/38.2 + .025 = .0693 or 6.93%
6. The common stock of Modern Interiors has a beta of 1.61 and a standard deviation of
27.4 percent. The market rate of return is 13.2 percent and the risk-free rate is 4.8 percent.
What is the cost of equity for this firm?
4.8+1.61*13.2-4.8 = 18.32%
7. Hi Tech Products has 35,000 bonds outstanding that are currently quoted at 102.3. The
bonds mature in 11 years and carry a 9 percent annual coupon. What is the firm's aftertax
cost of debt if the applicable tax rate is 35 percent?
9+100-102.3/11/100+102.3/2 = 8.79/101.15 = .0869 or 8.69%
After tax cost of debt = 8.69*.65 = 5.65%
8. Western Electric has 23,000 shares of common stock outstanding at a price per share of
$57 and a rate of return of 14.2 percent. The firm has 6,000 shares of 7 percent preferred
stock outstanding at a price of $48 a share. The preferred stock has a par value of $100.
The outstanding debt has a total face value of $350,000 and currently sells for 102
percent of face. The yield-to-maturity on the debt is 8.49 percent. What is the firm's
weighted average cost of capital if the tax rate is 34 percent?
Market
value
Common stock
Preferred stock
Bond

Weight
Cost
WACC
0.67024
9.517
1311000
54
14.2
48
0.14723
2.146
288000
93 14.58
75
0.18251 5.603 1.022
357000
53
4
71
12.69
1956000
1
%