QUESTION 1:
XYZ Inc. has 10 million shares of common stock outstanding. The
current share price is $20 per share. The most recent dividend was
$1 and the dividend growth rate is 4%.
XYZ also has a bond issue outstanding, which is maturing in 15
years, has a face value of $100 million, 7% coupon payable
annually, and sells for 83.8786% of the face value.
XYZ also has 2,000,000 preferred shares outstanding, which are
currently selling for $40 per share and pay a dividend of $3 per
year.
The Corporate tax rate is 40%.
Determine the weighted average cost of capital?
QUESTION 2:
Following are the probability distributions of annual returns of
ABC Enterprises and TSX Composite Index (market).
Probability RABC RTSXComp
0.20 5 2
0.50 11 6
0.30 14 10
a. Compute the expected annual returns, variances, and the standard
deviations for ABC
and the TSX Composite Index.
b. Compute the covariance.
c. Compute the coefficient of correlation and interpret it.
d. Compute the Beta for ABC and interpret it.
e. Using CAPM determine the required rate of return for ABC if the
risk free rate of
return is 4%.
QUESTION 3:
NoLev Limited an all equity firm has 1,000,000 shares of common
stock outstanding at $50 per share. Janice Outperform wants to
acquire a stake of 2% in NoLev but has not decided among the three
possible financing choices. She can create homemade leverage by
borrowing 40%, 50%, or 60% of the money she needs at a constant
interest rate of 8% per year. The return on equity of NoLev is 15%.
Assume an MM no tax world.
a. How much dollar return Janice expects to earn from her
investment each year under each of the three financing alternatives
respectively?
b. What are Janice’s returns on equity in each financing
alternative respectively?
c. What are Janice’s EPS in each financing alternative
respectively?
d. From parts (b) and (c), what inference can she draw about the
return on equity and EPS of a leveraged firm?
QUESTION 4:
AllEquity Inc., an all equity firm has total equity of $100,000,000
and has 5 million shares outstanding. AllEquity expects to have
EBIT of $15,000,000 per year in perpetuity. AllEquity is planning
to issue $50,000,000 of perpetual bonds at par. The bonds will have
a coupon rate of 8%. After the sale of the bonds AllEquity will
maintain the new capital structure indefinitely. AllEquity’s tax
rate is 40%.
a. What are AllEquity’s current value, cost of equity and the
WACC?
b. What is the AllEquity’s value after the announcement of the debt
issue?
c. How many shares of stock will AllEquity retire?
d. What is the AllEquity’s cost of equity and the WACC after the
capital restructuring has taken place.
QUESTION 5:
ABC Manufacturing currently has no debt. Joshua Optimal, VP –
Finance would like to estimate the optimal capital structure. The
following data are relevant for the analysis.
EBIT = $2,000,000 per year in perpetuity Tc = 40%
Dividend Payout ratio = 100% r0 = 10% rB = 6%
Present value of bankruptcy related costs = $5,000,000
Probabilities of bankruptcy at different debt levels are as
follows:
Debt Level (in millions of dollars) $0 2.5 5 7.5 10 12.5
Probability of Bankruptcy (%) 0 0 10 20 40 70
a. Determine the optimal level of debt.
b. Determine the weighted average cost of capital at the optimal
debt level.
QUESTION 1.
Note 1 : Cost of Common stock = D(1+g)/P_{0} + g
= 1(1+0.04)/20 + 0.04
= 1.04/20 + 0.04
= 0.092 or 9.2%
Note 2 : Cost of Debt using YTM formula
Approximate YTM = {C(1T) + (F  P) / n} / ((F + P) / 2)
Where...
YTM = Yield to Maturity
C = Coupon or Interest Payment
T = Tax rate
F = Face Value
P = Price
n = Years to Maturity
Thus, YTM = { $7(10.40) + ($100 $83.8786)/ 15} / ($100 + $83.8786) / 2
= {4.2 + 16.1214 /15 } / 183.8786 / 2
= 4.2 + 1.07476 / 91.9393
= 5.2748/91.9393
= 0.0574 or 5.74%
Note 3 : Cost of Preferred Stock = 3 / 40 = 0.075 or 7.5%
Note 4 : Weights
Value ( million) 
Weights 

Common Stock 
$ 200.00 
0.5496 
Debt 
$ 83.88 
0.2305 
Preferred Stock 
$ 80.00 
0.2199 
Total 
$ 363.88 
1 
Weighted Average cost of Capital = 9.2(0.5496) + 5.74(0.2305) + 7.5(0.2199)
= 8.03%
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