Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9780077861759
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 5, Problem 9CQ
The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake Project A. At a luncheon for shareholders, the manager of a pension fund that owns a substantial amount of the firm’s stock asks you why the firm chose Project A instead of Project B when Project B has a higher profitability index.
How would you, the CFO, justify your firm’s action? Are there any circumstances under which Global Investments should choose Project B?
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In financial analysis, it is important to select an appropriate discount rate. A project’s discount rate must be high to compensate investors for the project’s risk. The return that shareholders require from the company as a compensation for their investment risk is referred to as the cost of equity.
Consider this case:
Weghorst Co. is a 100% equity-financed company (no debt or preferred stock); hence, its WACC equals its cost of common equity. Weghorst Co.’s retained earnings will be sufficient to fund its capital budget in the foreseeable future. The company has a beta of 1.35, the risk-free rate is 4.5%, and the market return is 5.9%.
What is Weghorst Co.’s cost of equity?
1.95%
19.08%
8.02%
6.39%
Weghorst Co. is financed exclusively using equity funding and has a cost of equity of 10.65%. It is considering the following projects for investment next year:
Project
Required Investment
Expected Rate of Return
W
$23,575
9.65%
X…
In financial analysis, it is important to select an appropriate discount rate. A project's
discount rate must be high to compensate investors for the project's risk. The return that
shareholders require from the company as a compensation for their investment risk is
referred to as the cost of equity.
Consider this case:
The Shoe Building Inc. is a 100% equity-financed company (no debt or preferred
stock); hence, its WACC equals its cost of common equity. The Shoe Building Inc.'s
retained earnings will be sufficient to fund its capital budget in the foreseeable
future. The company has a beta of 1.50, the risk-free rate is 5.0%, and the market
return is 6.5%.
The Shoe Building Inc. is financed exclusively using equity funding and has a cost
of equity of 11.85%. It is considering the following projects for investment next
year:
Project
W
X
N
Required Investment
$8,750
$4,375
$2,150
$9,950
Expected Rate of Return
10.10%
13.65%
14.60%
14.10%
Each project has average risk, and The Shoe…
As the general manager of a firm, you are presented with an investment proposal from one of your divisions. Its net present value, if discounted at the cost of capital for your firm (which is 15 percent), is $ 1 00,000, and its internal rate of return is 20 percent. (a) What are the economic interpretations of the net present value and internal rate of return figures? In other words, what do they mean? (b) What, if any, additional information would you like to have before approving the project?
Chapter 5 Solutions
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 5 - Payback Period and Net Present Value If a project...Ch. 5 - Net Present Value Suppose a project has...Ch. 5 - Comparing Investment Criteria Define each of the...Ch. 5 - Payback and Internal Rate of Return A project has...Ch. 5 - International Investment Projects In March 2014,...Ch. 5 - Capital Budgeting Problems What are some of the...Ch. 5 - Prob. 7CQCh. 5 - Prob. 8CQCh. 5 - Net Present Value versus Profitability Index...Ch. 5 - Internal Rate of Return Projects A and B have the...
Ch. 5 - Net Present Value You are evaluating Project A and...Ch. 5 - Modified Internal Rate of Return One of the less...Ch. 5 - Net Present Value It is sometimes stated that the...Ch. 5 - Prob. 14CQCh. 5 - Calculating Payback Period and NPV Maxwell...Ch. 5 - Calculating Payback An investment project provides...Ch. 5 - Calculating Discounted Payback An investment...Ch. 5 - Calculating Discounted Payback An investment...Ch. 5 - Prob. 5QPCh. 5 - Calculating IRR Compute the internal rate of...Ch. 5 - Calculating Profitability Index Bill plans to open...Ch. 5 - Calculating Profitability Index Suppose the...Ch. 5 - Cash Flow Intuition A project has an initial cost...Ch. 5 - Prob. 10QPCh. 5 - NPV versus IRR Consider the following cash flows...Ch. 5 - Problems with Profitability Index The Coris...Ch. 5 - Prob. 13QPCh. 5 - Comparing Investment Criteria Wii Brothers, a game...Ch. 5 - Profitability Index versus NPV Hanmi Group, a...Ch. 5 - Comparing Investment Criteria Consider the...Ch. 5 - Comparing Investment Criteria The treasurer of...Ch. 5 - Comparing Investment Criteria Consider the...Ch. 5 - Prob. 19QPCh. 5 - NPV and Multiple IRRs You are evaluating a project...Ch. 5 - Payback and NPV An investment under consideration...Ch. 5 - Multiple IRRs This problem is useful for testing...Ch. 5 - NPV Valuation The Yurdone Corporation wants to set...Ch. 5 - Calculating IRR The Utah Mining Corporation is set...Ch. 5 - Prob. 25QPCh. 5 - Calculating IRR Consider two streams of cash...Ch. 5 - Calculating Incremental Cash Flows Darin Clay, the...Ch. 5 - Prob. 28QPCh. 5 - Prob. 1MCCh. 5 - Seth Bullock, the owner of Bullock Gold Mining, is...
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