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Financial Management Assignment Questions -

1. Explain why companies should discount projects using the cost of equity. When should they use the WACC instead? When should they use either?

2. Given the following information for ONAIR Co., find the WACC. Assume the company's tax rate is 35 percent.

Debt

10,000, 5% semi-annual payment coupon bonds outstanding. $1,000 par value, 30 years to maturity. Selling for 98% of par value. 

Common Stock

500,000 shares outstanding, selling for $70 per share, the beta is 1.2

Market

8% market risk premium and 4% risk-free rate

3. An all-equity firm is considering the following projects:

Project

Beta

IRR

A

0.75

8.4%

B

0.95.

12.6%

C

1.15

13.5%

D

1.32

14.5%

E

1.45

15.9%

The T-bill rate is 3 percent, and the expected return on the market is 12 percent.

a. Which projects have a higher expected return than the firm's 13 percent cost of capital?

b. Which projects should be accepted? Why?

4. Graham Co. considers taking a new project that will generate after-tax cash savings of $1.85 million at the end of the first year, and these savings will grow at a rate of 5% per year forever. The company has a target debt/equity ratio of .55, a cost of equity of 15%, and an after-tax cost of debt of 6 percent. Since the cost-saving proposal is riskier than the usual projects Graham Co. takes, managers estimate that the cost of the capital of the new project will be 2.8% higher than that of company's overall projects. What is the maximum cost of the project that the company should take the new project? Please show your work.

5. Assume that capital markets are perfect. A firm finances its operations via $60 million in stock with a required return of 15% and $40 million in bonds at 8%. Assume the company can use the proceeds to retire $10 million worth of equity, (a) what would happen to the firm's WACC? (4 points)(b) What would happen to the required return on the company's stock?

6. Assume a borrower made a mortgage loan five years ago for $180,000 at 8 % interest for 30 years (monthly payment). After five years, interest rates fall, and a new mortgage loan is available at 7.5 percent for 25 years. The loan balance on the existing loan is $171,125.74. Suppose the closing cost for the new loan will be $5,500 plus $150 for recording fees. Should the borrower refinance?

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