Capital Budgeting

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1a.   You have been hired as a consultant to help estimate the cost of capital.  You have been provided with the following data:  rRF = 4.10%; RPM = 5.25%; and b = 1.30.  Based on the CAPM approach, what is the cost of common from retained earnings?


1b.  A company is trying to estimate its cost of capital.  The following data is provided:  D1 = $1.45; P0 = $22.50; and g = 6.50% (constant).  Based on the DCF approach, what is the cost of common from retained earnings?


  1. Suppose you are informed that a company expects to pay a $2.50 dividend at year end

(D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share.  The before-tax cost of debt is 7.50%, and the tax rate is 40%.  The target capital structure consists of 45% debt and 55% common equity.  What is the company’s WACC if all the equity used is from retained earnings?








  1. Based on the dollar value presented in the table below, what is the project’s regular payback period?  What is the project’s discounted payback period?


WACC: 10.00%        
Year 0 1 2 3 4
Cash flows -$950 $525 $485 $445 $405






  1. Based on the cash flow and WACC data below, what is this project’s NPV? Based on your answer for the NPV, should this project be accepted or rejected? Briefly explain.


WACC: 12.00%          
Year 0 1 2 3 4 5
Cash flows -$1,100 $400 $390 $380 $370 $360









  1. As an internship project you are given the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s MIRR can be less than the WACC (and even negative), in which case it will be rejected.


WACC: 12.25%        
Year 0 1 2 3 4
Cash flows -$850 $300 $320 $340 $360








  1. A company you are consulting is considering Projects 1 and 2, whose cash flows are shown in the table below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, however the CFO favors the NPV method. Your consulting job is to advise the form on the best procedure. What is the NPV for each project?  What is the IRR for each project?  Finally, if the wrong decision criterion is used how much potential value (in terms of lost NPV) would the company lose?




WACC: 6.00%        
Year 0 1 2 3 4
CF1 -$1,025 $380 $380 $380 $380
CF2 -$2,150 $765 $765 $765 $765


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