1 The corporate treasurer of Ajax Company expects the company to grow at 4% in t
ID: 2673326 • Letter: 1
Question
1 The corporate treasurer of Ajax Company expects the company to grow at 4% in the future, and debt securities
at 6% interest (tax rate = 30%) to be a cheaper option to finance the growth. The current market price per share
of its common stock is $39, and the expected dividend in one year is $1.50 per share. Calculate the cost of the company's
retained earnings and check if the treasurer's assumption is correct.
2 The risk-free rate on 10-year U.S. Treasury bills is 3% and the expected rate of return on the overall stock market is 11%.
The company has a beta of 1.6. What is the cost of equity?
3 A company has a capital structure as follows:
Total Assets $600,000
Debt $300,000
Preferred Stock $100,000
Common Equity $200,000
What would be the minimum expected return from a new capital investment project to satisfy the suppliers of the capital?
Assume the applicable tax rate is 40%, interest on debt is 11%, flotation cost per share of preferred stock is $0.75, and
flotation cost per share of common stock is $4. The preferred and common stocks are selling in the market for $26 and $143
a share respectively, and they are expected to pay a dividend of $2 and $7, repectively, in one year. The company's dividends
are expected to grow at 13% per year. The firm would like to maintain the existing capital structure to finance the new
project.
4 Required rate of return is 10%.
Net Cash Flow
Year Project A Project B
0 -$2,000 -$2,500
1 $900 $1,500
2 $1,100 $1,300
3 $1,300 $800
a) Calculate the payback period for each project.
b) Calculate the net present value for each project.
c) Which project do you think will be approved, if only one project can be approved? Why?
d) What if the required rate of return was 20%?
5 A corporate bond has a face value of $1,000 and an annual coupon interest rate of 7%. Interest is paid annually.
10 years of the life of the bond remain. The current market price of the bond is $872. To the nearest whole percent,
what is the yield to maturity (YTM) of the bond today?
6 Ajax Manufacturing dividend is $8 per share of common stock in one year. The dividend growth rate is 3%.
Required rate of return is 14%.
a) What is the current market price per share?
b) What is the annual rate of return if you purchase the stock at $65?
7. A common stock sells for $82 per share, has a growth rate of 7% and a dividend that was just paid of $3.82. What is the
annual percent yield per share?
8 A corporate bond has a face value of $1,000 and an annual coupon interest rate of 6%. Interest is paid annually.
12 years of the life of the bond remain. The current market price of the bond is $1,027, and it will mature at $1,100.
To the nearest whole percent, what is the yield to maturity (YTM) of the bond today?
Explanation / Answer
The corporate treasurer of Ajax Company expects the company to grow at 4% in the future, and debt securities at 6% interest (tax rate = 30%) to be a cheaper option to finance the growth. The current market price per share of its common stock is $39, and the expected dividend in one year is $1.50 per share. Calculate the cost of the company's retained earnings and check if the treasurer's assumption is correct. Answer: Cost of debt after tax is 4.20% Cost of retained earnings is 7.85% ========================================================================================================================================================================================================================================================= The risk-free rate on 10-year U.S. Treasury bills is 3% and the expected rate of return on the overall stock market is 11%. The company has a beta of 1.6. What is the cost of equity? Answer: The cost of equity is 15.80% ========================================================================================================================================================================================================================================================= A company has a capital structure as follows: Total Assets $600,000 Debt $300,000 Preferred Stock $100,000 Common Equity $200,000 What would be the minimum expected return from a new capital investment project to satisfy the suppliers of the capital? Assume the applicable tax rate is 40%, interest on debt is 11%, flotation cost per share of preferred stock is $0.75, and flotation cost per share of common stock is $4. The preferred and common stocks are selling in the market for $26 and $143 a share respectively, and they are expected to pay a dividend of $2 and $7, repectively, in one year. The company's dividends are expected to grow at 13% per year. The firm would like to maintain the existing capital structure to finance the new project. Answer: The minimum expected return from a new capital investment project is the WACC plus any additional risk premium. Since no additional risk is mentioned, we will use the WACC. Cost of debt after tax is 6.60% Cost of preferred stock is 7.92% Cost of common stock is 18.04% WACC is 10.63% Required rate of return is 10%. Net Cash Flow Year Project A Project B 0 -$2,000 -$2,500 1 $900 $1,500 2 $1,100 $1,300 3 $1,300 $800 Calculate the payback period for each project. Project A Project B Answer: 2.00 1.77 Payback Period in years. ========================================================================================================================================================================================================================================================= Calculate the net present value for each project. Project A Project B Answer: $703.98 $539.07 ========================================================================================================================================================================================================================================================= Which project do you think will be approved, if only one project can be approved? Why? Project A Project B Answer: Yes No ========================================================================================================================================================================================================================================================= What if the required rate of return was 20%? Answer: Project A Project B $266.20 $115.74 Net Present Value Yes No ========================================================================================================================================================================================================================================================= A corporate bond has a face value of $1,000 and an annual coupon interest rate of 7%. Interest is paid annually. 10 years of the life of the bond remain. The current market price of the bond is $872. To the nearest whole percent, what is the yield to maturity (YTM) of the bond today? Answer: 9% ========================================================================================================================================================================================================================================================= Ajax Manufacturing dividend is $8 per share of common stock in one year. The dividend growth rate is 3%. Required rate of return is 14%. What is the current market price per share? Answer: $72.73 ========================================================================================================================================================================================================================================================= What is the annual rate of return if you purchase the stock at $65? Answer: 15.31% ========================================================================================================================================================================================================================================================= A common stock sells for $82 per share, has a growth rate of 7% and a dividend that was just paid of $3.82. What is the annual percent yield per share? D0 = $3.82 and therefore D1 = $3.82 x 1.07 = $4.09 Answer: 11.98% ========================================================================================================================================================================================================================================================= A corporate bond has a face value of $1,000 and an annual coupon interest rate of 6%. Interest is paid annually.12 years of the life of the bond remain. The current market price of the bond is $1,027, and it will mature at $1,100. To the nearest whole percent, what is the yield to maturity (YTM) of the bond today? Answer: 6% =========================================================================================================================================================================================================================================================
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