Finance Questions Written Analysis Other (not Listed Above)

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Financial Situations

The first calculation is the cost of debt. This is done on an after-tax basis. The before-tax cost of debt is 4% and the tax rate is 35%. So the after-tax cost of debt is 65% of the before-tax cost of debt, thus 2.6%. The cost of retained earnings is calculated by dividing the current stock price by the expected dividend. This gives a value of 3.85%, to which the 3% growth rate is added, giving a cost of retained earnings of 6.85%.

The cost of equity is calculated using the capital asset pricing model. The market risk premium (12-3.25) is multiplied by the beta to get 14%, and then the risk free rate of 3.25% is added to this to give a cost of equity of 17.25%.

The same calculation is done for this one, but different numbers are used. The market risk premium is (5-2) = 3%, to which the beta is multiplied for a value of 4.8%. The risk free rate of 2% is added to this to give a cost of equity of 6.8%.

The WACC is the weighted average cost of capital. The weights for the three capital types are 40% debt, 10% preferred and 50% common. The cost of debt is done on an after-tax basis the same as above; common equity is calculated using the CAPM, less flotation cost. The preferreds are calculated as the preferred dividend ($1.50) divided by the price of the preferred ($26) less flotation cost ($0.

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75). The cost of each type of financing is multiplied by its weight in order to derive the weighted average cost of capital.

4. This question covers a number of different capital budgeting evaluation methods. Payback period is done bluntly, by counting down the money earned by the project against the original outlay. B is the net present value, which is calculated when you run the cash flows through the NPV calculation in Excel, using the discount rate provided. The project that will be approved is the one that has the highest NPV. To calculate with a new rate of return, simply plug the new number (10%) into the old formula. The internal rate of return can be calculated using the IRR function in Excel. NPV is the best method of deciding. It uses the same underlying math as IRR, but the NPV takes into account the total dollar value that is added to the company. When evaluating mutually exclusive projects, the one that adds the most value is more important than the one with the highest rate of return.

5. YTM is calculated a yield to maturity calculator, given the inputs. The basic principle is the total yield will be all of the interest payments, less the premium paid.

6. A is calculated using the dividend discount model to….....

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